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Reallocation and restructuring: A generalization of the Balassa–Samuelson effect

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  • Borgersen, Trond-Arne
  • King, Roswitha M.
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    Abstract

    Despite its strong theoretical position when it comes to explaining inflation in transition economies, the empirical findings of the Balassa–Samuelson (B–S) effect assign only a minor role to structural inflation – to the disappointment of analysts and policymakers. This article points to 3 theory-based contributing factors to these ‘weak’ findings and offers an alternative methodological approach. First, a short-term focus makes B–S prone to underestimating the magnitude of the productivity growth differential. Second, the conventional demand side CPI based definition of sectoral value added reduces the extent to which the productivity growth differential is passed through to inflation. Third, by ignoring the dependence between the 2 main B–S components, a further downward bias to the productivity growth pass through comes about. The key to our proposed alternative methodology centres on an endogenous relation between the productivity growth differential and sector sizes. Together with the long-run supply-side approach this allows us to capture inflation drivers that conventional B–S fails to incorporate. In our extension to the conventional B–S model a reduced productivity growth differential can be compensated by an increased productivity growth pass-through, or vice versa – with the effect of augmenting inflation pressure. Hence, the link between productivity growth differentials and the dynamics of structural inflation is shown to be more complex than previously assumed.

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    Bibliographic Info

    Article provided by Elsevier in its journal Structural Change and Economic Dynamics.

    Volume (Year): 22 (2011)
    Issue (Month): 4 ()
    Pages: 287-298

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    Handle: RePEc:eee:streco:v:22:y:2011:i:4:p:287-298

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    Web page: http://www.elsevier.com/locate/inca/525148

    Related research

    Keywords: Balassa–Samuelson; Structural inflation; Scandinavian model of inflation; Reallocation; Restructuring;

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    References

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    1. Coricelli, Fabrizio & Jazbec, Bostjan, 2001. "Real Exchange Rate Dynamics in Transition Economies," CEPR Discussion Papers 2869, C.E.P.R. Discussion Papers.
    2. Holger C. Wolf & Alberto Giovannini & Jose De Gregorio, 1994. "International Evidence on Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
    3. Herr, Hansjörg, 2009. "Time, expectations and financial markets," IPE Working Papers 03/2009, Berlin School of Economics and Law, Institute for International Political Economy (IPE).
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    7. Halpern, László & MacDonald, Ronald & Égert, Balázs, 2005. "Equilibrium Exchange Rates in T ransition Economies: T aking Stock of the Issues," Working Papers 106, Oesterreichische Nationalbank (Austrian Central Bank).
    8. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    9. Egert, Balazs & Drine, Imed & Lommatzsch, Kirsten & Rault, Christophe, 2003. "The Balassa-Samuelson effect in Central and Eastern Europe: myth or reality?," Journal of Comparative Economics, Elsevier, vol. 31(3), pages 552-572, September.
    10. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584.
    11. Paul De Grauwe & Magdalena Polan, 2005. "Is Inflation Always and Everywhere a Monetary Phenomenon?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 107(2), pages 239-259, 06.
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