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Productivity shocks and real exchange rate: a reappraisal

  • Peltonen, Tuomas A.
  • Sager, Michael

We reappraise the relationship between productivity and equilibrium real exchange rates using a panel estimation framework that incorporates a large number of countries and importantly, a dataset that allows explicit consideration of the role of non-traded, as well as traded, sector productivity shocks in exchange rate determination. We find evidence of significant correlation between real exchange rates and productivity differentials in both sectors. But our finding of a significant role for the non-traded sector in exchange rate determination, and of a relatively larger correlation between exchange rates and productivity shocks of a given size emanating from this sector, represent clear contradictions of the widely cited Balassa-Samuelson hypothesis. Our findings remain valid in the face of a number of robustness tests, including the exchange rate regime and numéraire currency. JEL Classification: F31, O47, C23

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Paper provided by European Central Bank in its series Working Paper Series with number 1046.

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Date of creation: Apr 2009
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Handle: RePEc:ecb:ecbwps:20091046
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