Relative labor productivity and the real exchange rate in the long run: evidence for a panel of OECD countries

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.

Is there a base currency effect in long-run PPP?

“…For instance, employing CPI-based RERs, Jorion and Sweney (1996), Papell (1997Papell ( , 1998, Koedijk et al (1998) and Theodoridis (1997, 1998) claim that evidence for PPP is stronger from the mark series than from the corresponding dollar series. Canzoneri et al (1999) using the BalassaSamuelson model and Wei and Parsley (1995) reach a similar conclusion for tradable prices.…”

Fiscal Shocks and The Sectoral Composition of Output

“…We allocate sectors to the nontradables and tradables categories following Canzoneri et al (1999), Galstyan andObstfeld (2009). That is, real output in the nontradable sector is the sum of the real added value in 'Construction', 'Wholesale and Retail Trade', 'Hotels and Restaurants', 'Transport and Storage and Communication', 'Finance, Insurance, Real Estate and Business Services', 'Public Administration and Defence; Compulsory Social Security', 'Education', 'Health and Social Work' and 'Other Community, Social and Personal Services'.…”

Internal and external exchange rate equilibrium in a cointegration framework. An application to the Spanish peseta

“…Since any of the above explanations may potentially drive the long-run behaviour of the internal real exchange rate, they rather serve as a warning for the interpretation of the results below. In any case, it is a well-established fact that, in the long run, sectoral productivity differentials tend to generate sectoral inflation differentials 4 .…”

“…(17)3 See deGregorio et al (1994), for further discussion 4. See Alberola and Tyrväinen (1998) orCanzoneri et al (1999) 5. Alberola and Tyrväinen (1998) compute the shares of non-tradables in the CPI index for EMU countries and the range is between 62 and 72%.…”