Do relative prices of nontraded goods explain relative movements in price indices

Inclusion of nontraded goods prices has been shown to be partly responsible for slow convergence in price indices across major cities in the United States (Cecchetti et al 2002). Drawing upon insights provided by well known theories, this paper uses panel econometric methods to seek evidence in U.S. city level Consumer Price Index (CPI) data of a systematic long-run relationship between prices of nontraded goods relative to traded goods, and overall relative price. While the results for convergence of overall relative prices are mixed, the hypothesis of a long-run relationship between overall relative prices and relative prices of nontraded goods is overwhelmingly rejected. However, the evidence of cointegration between relative prices of nontraded goods across cities suggests that relative movements of overall prices could be driven by temporary shocks that move nontraded goods prices away from their long-run paths.