Violating the Law of One Price: Should We Make A Federal Case Out of It?

We use new disaggregated data on consumer prices to determine why there is variability in prices of similar goods across U.S. cities. We address questions similar to those that have arisen in the international context: is this variability purely a result of market segmentation or do sticky nominal prices play a role? We also examine how the degree of tradability of a good influences price variability. Surprisingly, we find that variability is larger for traded-goods. We attribute this finding to greater price stickiness for non-traded goods. Distance between cities accounts for a significant amount of the variation in prices between pairs of cities. But we also find that nominal price stickiness plays an even more significant role. We thank Dwight Bibbs, Gabriele Galati, Sharon Gibson and Dave Wilcox for assistance with the data, and Asim Husain for outstanding research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect those of the Board of Governors of the Federal Reserve or the Federal Reserve System. Engel acknowledges assistance from a grant by the National Science Foundation to the National Bureau of Economic Research.