One Country,Two Prices? A Study of the Deflationary Effect of Price Convergence on Hong Kong*

Consumer prices in Hong Kong at the time of writing have declined by 15 percent from the peak recorded in 1998. We investigate the deflationary impact on Hong Kong of price convergence with the Mainland China, using 1990–2001 annual data on commodity prices in the former and in major cities of the latter. We find evidence of price convergence between the two economies over the past decade. Furthermore, price convergence is estimated to have accounted for one‐fifth of the deflation in Hong Kong. The results suggest that a significant portion of the deflation in Hong Kong is attributable to a process of structural adjustment due to growing economic integration with the Mainland.