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Deviations in real exchange rate levels in the OECD countries and their structural determinants

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Abstract

The most commonly used theoretical framework describing why prices in some countries are higher than in others (i.e. explaining deviations from purchasing power parity) is the Balassa-Samuelson model. The Balassa-Samuelson model implies that stronger productivity growth should tend to cause a country's real exchange rate to appreciate. This paper develops measures of productivity and real exchange rate levels across industries and countries to allow the Balassa-Samuelson hypothesis to be tested. We show that the model finds empirical support in 17 OECD economies: there is a link between real exchanges and sectoral productivity levels both across countries and over time. We then show theoretically and empirically that relaxing the model's assumptions about wage determination and the role of labour market differences across sectors and countries helps improve the performance of the model. However, there remains large unexplained deviations in real exchange rates across countries that the model cannot account for.

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  • Martin Berka & Daan Steenkamp, 2018. "Deviations in real exchange rate levels in the OECD countries and their structural determinants," Reserve Bank of New Zealand Discussion Paper Series DP2018/08, Reserve Bank of New Zealand.
  • Handle: RePEc:nzb:nzbdps:2018/8
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    Cited by:

    1. Couharde, Cécile & Delatte, Anne-Laure & Grekou, Carl & Mignon, Valérie & Morvillier, Florian, 2020. "Measuring the Balassa-Samuelson effect: A guidance note on the RPROD database," International Economics, Elsevier, vol. 161(C), pages 237-247.
    2. Michael Fidora & Claire Giordano & Martin Schmitz, 2021. "Real Exchange Rate Misalignments in the Euro Area," Open Economies Review, Springer, vol. 32(1), pages 71-107, February.
    3. Carl Grekou, 2019. "EQCHANGE Annual Assessment 2019," Working Papers 2019-19, CEPII research center.
    4. Daan Steenkamp, 2018. "Factor Substitution and Productivity in New Zealand," The Economic Record, The Economic Society of Australia, vol. 94(304), pages 64-79, March.
    5. Claire Giordano, 2021. "How frequent a BEER? Assessing the impact of data frequency on real exchange rate misalignment estimation," Scottish Journal of Political Economy, Scottish Economic Society, vol. 68(3), pages 365-404, July.
    6. Florian Morvillier, 2020. "Robustness of the Balassa-Samuelson effect: evidence from developing and emerging economies," EconomiX Working Papers 2020-18, University of Paris Nanterre, EconomiX.

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    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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