The Harrod–Balassa–Samuelson Hypothesis: Real Exchange Rates And Their Long‐Run Equilibrium

Frictions and perturbations may influence currency values in the short run, but it is generally acknowledged that real‐exchange rates eventually settle toward equilibrium. The puzzle then is how gradually this parity is reached given the fluidity in foreign exchange markets. Persistent differences in the relative productivity of countries—a broad characterization of the Harrod–Balassa–Samuelson hypothesis—may help explain this puzzle. This article introduces methods to estimate equilibrium adjustment paths semiparametrically, and then sort how each of these components influences the dynamics of exchange rates. This is done in a dynamic panel setting by introducing novel local projections methods for cointegrated systems. Productivity shocks affect dynamics, and after adjusting for these factors, adjustment toward equilibrium is relatively rapid.