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The Harrod-Balassa-Samuelson Hypothesis: Real Exchange Rates and their Long-Run Equilibrium

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  • Chong, Yanping
  • Jordà, Òscar
  • Taylor, Alan M.

Abstract

Frictionless, perfectly competitive traded-goods markets justify thinking of purchasing power parity (PPP) as the main driver of exchange rates in the long-run. But differences in the traded/non-traded sectors of economies tend to be persistent and affect movements in local price levels in ways that upset the PPP balance (the underpinning of the Harrod-Balassa-Samuelson hypothesis, HBS). This paper uses panel-data techniques on a broad collection of countries to investigate the long-run properties of the PPP/HBS equilibrium using novel local projection methods for cointegrated systems. These semi-parametric methods isolate the long-run behavior of the data from contaminating factors such as frictions not explicitly modelled and thought to have effects only in the short-run. Absent the short-run effects, we find that the estimated speed of reversion to long-run equilibrium is much higher. In addition, the HBS effects means that the real exchange rate is converging not to a steady mean, but to a slowly to a moving target. The common failure to properly model this effect also biases the estimated speed of reversion downwards. Thus, the so-called

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7902.

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Date of creation: Jun 2010
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Handle: RePEc:cpr:ceprdp:7902

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Keywords: cointegration; Harrod-Balassa-Samuelson hypothesis; local projections; panel data;

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References

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  1. Peter Pedroni, 2004. "Panel Cointegration: Asymptotic and Finite Sample Properties of Pooled Time Series Tests with an Application to the PPP Hypothesis," Department of Economics Working Papers 2004-15, Department of Economics, Williams College.
  2. Damiaan Persyn, 2008. "XTWEST: Stata module for testing for cointegration in heterogeneous panels," Statistical Software Components S456941, Boston College Department of Economics, revised 29 Jun 2010.
  3. Laszlo Halpern & Charles Wyplosz, 2001. "Economic Transformation and Real Exchange Rates in the 2000s: The Balassa-Samuelson Connection," ECE Discussion Papers Series 2001_1, UNECE.
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  1. BDSM: il meraviglioso mondo di...
    by Alberto Bagnai in Goofynomics on 2013-02-05 22:44:00
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Cited by:
  1. Coen Teulings & Nick Zubanov, 2011. "Is economic recovery a myth? Robust estimation of impulse responses," CPB Discussion Paper 131, CPB Netherlands Bureau for Economic Policy Analysis.
  2. Richard Frensch & Achim Schmillen, 2011. "The Penn Effect and Transition : The New EU Member States in International Perspective," Working Papers 295, Institut für Ost- und Südosteuropaforschung (Institute for East and South-East European Studies).
  3. Christopoulos, Dimitris K. & Gente, Karine & León-Ledesma, Miguel A., 2012. "Net foreign assets, productivity and real exchange rates in constrained economies," European Economic Review, Elsevier, vol. 56(3), pages 295-316.
  4. Dong He & Lillian Cheung & Wenlang Zhang & Tommy Wu, 2012. "How would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 20(6), pages 29-54, November.
  5. Jordà, Òscar & Taylor, Alan M., 2012. "The carry trade and fundamentals: Nothing to fear but FEER itself," Journal of International Economics, Elsevier, vol. 88(1), pages 74-90.

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