Working Paper: NBER ID: w5676
Authors: Matthew B. Canzoneri; Robert E. Cumby; Behzad Diba
Abstract: The Balassa-Samuelson model, which explains real exchange rate movements in terms of sectoral productivities, rests on two components. First, for a class of technologies including Cobb-Douglas, the model implies that the relative price of nontraded goods in each country should reflect the relative productivity of labor in the traded and nontraded goods sectors. Second, the model assumes that purchasing power parity holds for traded goods in the long-run. We test each of these implications using data from a panel of OECD countries. Our results suggest that the first of these two fits the data quite well. In the long run, relative prices generally reflect relative labor productivities. The evidence on purchasing power parity in traded goods is considerably less favorable. When we look at US dollar exchange rates, PPP does not appear to hold for traded goods, even in the long run. On the other hand, when we look at DM exchange rates purchasing power parity appears to be a somewhat better characterization of traded goods prices.
Keywords: Real Exchange Rate; Labor Productivity; Balassa-Samuelson Model; Purchasing Power Parity; OECD Countries
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| relative price of nontraded goods (F16) | ratio of average labor productivity (J24) |
| productivity in traded goods grows faster than in nontraded goods at home compared to abroad (F14) | real appreciation of home currency (F31) |
| failure of PPP model to explain real exchange rate movements (F31) | real exchange rates (F31) |
| evidence for PPP is more favorable when using Deutsche Mark exchange rates (F31) | real exchange rates (F31) |
| long-run trends allow for a better understanding of relationships (C22) | causal identification through cointegration tests (C32) |