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The Balassa-Samuelson and the Penn Effect: Are They Really the Same?

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  • Cosimo Pancaro

    (European Central Bank (ECB))

Abstract

According to the Balassa-Samuelson effect, productivity gains in the domestic tradable sector raise the relative price of domestic non-tradables causing deviations from the purchasing power parity. In the literature, the Balassa-Samuelson effect is typically invoked to explain the Penn effect, according to which the price level is higher in richer countries, so that their real income is overstated if converted at market exchange rates. In this paper, using a two-country, two-sector international real business cycle model, which closely follows Stockman and Tesar (1995) and Benigno and Thoenissen (2008), we show that the Balassa-Samuelson effect only explains the Penn effect either for a sufficiently high trade elasticity or for a low degree of home bias; if asset markets are incomplete, furthermore, it does so also in the presence of high complementarity between tradables and non-tradables or for a low share of tradables in consumption. These results are coherent with the empirical evidence, which generally supports the prediction of the Balassa-Samuelson model about relative price of non-tradables but is more controversial about real exchange rate appreciation in response to productivity gains in tradables.

Suggested Citation

  • Cosimo Pancaro, 2013. "The Balassa-Samuelson and the Penn Effect: Are They Really the Same?," Swiss Finance Institute Research Paper Series 13-03, Swiss Finance Institute.
  • Handle: RePEc:chf:rpseri:rp1303
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    Cited by:

    1. Bechlioulis, Alexandros P. & Brissimis, Sophocles N., 2019. "Consumer debt non-payment and the borrowing constraint: Implications for consumer behavior," Journal of Banking & Finance, Elsevier, vol. 101(C), pages 161-172.
    2. Echeverria Garaigorta, Paulina Elisa & Iza Padilla, María Amaya, 2010. "Prices and the Real Exchange Rate in Hong Kong: 1985-2006," DFAEII Working Papers 2010-14, University of the Basque Country - Department of Foundations of Economic Analysis II.
    3. Eiji Fujii, 2015. "Reconsidering The Price–Income Relationship Across Countries," Pacific Economic Review, Wiley Blackwell, vol. 20(5), pages 733-760, December.
    4. Gabor Oblath & Eva Palocz & David Popper & Akos Valentinyi, 2015. "Economic convergence and structural change in the new member states of the European Union Convergence in volumes, prices and the share of services, with implications for wage convergence: an expenditu," CERS-IE WORKING PAPERS 1544, Institute of Economics, Centre for Economic and Regional Studies.

    More about this item

    Keywords

    Balassa-Samuelson effect; Penn effect; real exchange rate;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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