Financial Development and Real Price Level Differences

Real price levels are systematically lower in developing countries than in developed countries. This paper provides time series evidence about the effect of financial development on real price level differences for 40 developing countries. Based on cointegration tests, we find a long-run equilibrium relationship between financial development and real price level differences in 21 countries. We also find that in 7 countries financial development Granger-causes real price level differentials, while for 19 countries the causality runs in the opposite direction. Country-specific institutional or political-economy differences, typically ignored in cross-section analysis, likely play an important role in real price level differences