Price Level Convergence among Italian Cities: Any Role for the Harrod-Balassa-Samuelson Hypothesis?

Abstract

Abstract. The purpose of this paper is to explain divergences in relative prices among cities participating in the same currency area, such as Italy. According to our results, we find relative prices mean reverting, but at a very slow rate. We employ both univariate and panel unit roots tests, the latter counting jointly for the cross-section and time dimension, over a sample of more than fifty years. The measure of persistence is high also in a well-established “monetary union ” such as Italy, where some of the standard reasons behind both short-term dynamics of the PPP and long-lasting deviations from the parity such as tariff or nominal exchange rate movements, are minimised or negligible. This may be the result of both short-term cyclical factors or of a more long-term nature. In the present work, we motivated price level divergence by two main explanations. First, arbitrage impediments due to transportation costs, account for part of this divergence. Second, the Harrod-Balassa-Samuelson effect, the well-known empirical regularity between productivity and inflation differentials across tradables and nontradables, is also found to be partially responsible for such persistence. The core of the Harrod-Balassa-Samuelson hypothesis explains how differentials in productivity growth between the two sectors of tradable and non-tradable goods may lead, within a given country, to inflation differentials by altering the internal price structure. In the case at hand,

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