IDEAS home Printed from https://ideas.repec.org/p/cer/papers/wp547.html
   My bibliography  Save this paper

A Small Open Economy with the Balassa-Samuelson Effect

Author

Listed:
  • Robert Ambrisko

Abstract

The Balassa-Samuelson (B-S) effect implies that highly productive countries have higher inflation and appreciating real exchange rates because of larger productivity growth differentials between tradable and nontradable sectors relative to advanced economies. The B-S effect might pose a threat to converging European countries, which would like to adopt the Euro because of the limits imposed on inflation and nominal exchange rate movements by the Maastricht criteria. The main goal of this paper is to judge whether the B-S effect is a relevant issue for the Czech Republic to comply with selected Maastricht criteria before adopting the Euro. For this purpose, a two-sector DSGE model of a small open economy is built and estimated using Bayesian techniques. The simulations from the model suggest that the B-S effect is not an issue for the Czech Republic when meeting the inflation and nominal exchange rate criteria. The costs of early adoption of the Euro are not large in terms of additional inflation pressures, which materialize mainly after the adoption of the single currency. Also, nominal exchange rate appreciation, driven by the B-S effect, does not breach the limit imposed by the ERM II mechanism.

Suggested Citation

  • Robert Ambrisko, 2015. "A Small Open Economy with the Balassa-Samuelson Effect," CERGE-EI Working Papers wp547, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
  • Handle: RePEc:cer:papers:wp547
    as

    Download full text from publisher

    File URL: http://www.cerge-ei.cz/pdf/wp/Wp547.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Federico Ravenna & Fabio M. Natalucci, 2008. "Monetary Policy Choices in Emerging Market Economies: The Case of High Productivity Growth," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(2-3), pages 243-271, March.
    2. Fabio Ghironi & Marc J. Melitz, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 120(3), pages 865-915.
    3. Michael B. Devereux, 2003. "A Macroeconomic Analysis of EU Accession under Alternative Monetary Policies," Journal of Common Market Studies, Wiley Blackwell, vol. 41(5), pages 941-964, December.
    4. Balázs Égert & László Halpern & Ronald MacDonald, 2006. "Equilibrium Exchange Rates in Transition Economies: Taking Stock of the Issues ," Journal of Economic Surveys, Wiley Blackwell, vol. 20(2), pages 257-324, April.
    5. Bela Balassa, 1964. "The Purchasing-Power Parity Doctrine: A Reappraisal," Journal of Political Economy, University of Chicago Press, vol. 72, pages 584-584.
    6. Lipinska, Anna, 2006. "The Maastricht convergence criteria and optimal monetary policy for the EMU accession countries," MPRA Paper 1795, University Library of Munich, Germany.
    7. Tomas Holub & Martin Cihak, 2003. "Price Convergence: What Can the Balassa-Samuelson Model Tell Us?," Working Papers 2003/08, Czech National Bank.
    8. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Stabilization policy and the costs of dollarization," Proceedings, Federal Reserve Bank of Cleveland, pages 482-517.
    9. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
    10. 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.
    11. Martin Èihák & Tomáš Holub, 2003. "Price Convergence: What Can the Balassa-Samuelson Model Tell Us? (in English)," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 53(7-8), pages 334-355, July.
    12. Laxton, Douglas & Pesenti, Paolo, 2003. "Monetary rules for small, open, emerging economies," Journal of Monetary Economics, Elsevier, vol. 50(5), pages 1109-1146, July.
    13. Masten, Igor, 2008. "Optimal monetary policy with Balassa-Samuelson-type productivity shocks," Journal of Comparative Economics, Elsevier, vol. 36(1), pages 120-141, March.
    14. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    15. Pau Rabanal, 2009. "Inflation Differentials between Spain and the EMU: A DSGE Perspective," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(6), pages 1141-1166, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Balassa-Samuelson effect; DSGE; European Monetary Union; exchange rate regimes; Maastricht convergence criteria;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cer:papers:wp547. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jana Koudelkova). General contact details of provider: http://edirc.repec.org/data/eiacacz.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.