The Harrod-Balassa-Samuelson Hypothesis: Real Exchange Rates and Their Long-Run Equilibrium

31 Pages Posted: 5 Apr 2010  

Yanping Chong

Winona State University - Department of Economics

Oscar Jorda

University of California, Davis - Department of Economics; Federal Reserve Banks - Federal Reserve Bank of San Francisco

Alan M. Taylor

University of California, Davis - Department of Economics; University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: April 2010

Abstract

Frictionless, perfectly competitive traded-goods markets justify thinking of purchasing power parity (PPP) as the main driver of exchange rates in the long-run. But differences in the traded/non-traded sectors of economies tend to be persistent and affect movements in local price levels in ways that upset the PPP balance (the underpinning of the Harrod-Balassa-Samuelson hypothesis, HBS). This paper uses panel-data techniques on a broad collection of countries to investigate the long-run properties of the PPP/HBS equilibrium using novel local projection methods for cointegrated systems. These semi-parametric methods isolate the long-run behavior of the data from contaminating factors such as frictions not explicitly modelled and thought to have effects only in the short-run. Absent the short-run effects, we find that the estimated speed of reversion to long-run equilibrium is much higher. In addition, the HBS effects means that the real exchange rate is converging not to a steady mean, but to a slowly to a moving target. The common failure to properly model this effect also biases the estimated speed of reversion downwards. Thus, the so-called "PPP puzzle" is not as bad as we thought.

Suggested Citation

Chong, Yanping and Jorda, Oscar and Taylor, Alan M., The Harrod-Balassa-Samuelson Hypothesis: Real Exchange Rates and Their Long-Run Equilibrium (April 2010). NBER Working Paper No. w15868. Available at SSRN: https://ssrn.com/abstract=1583809

Yanping Chong (Contact Author)

Winona State University - Department of Economics ( email )

175 W Mark Street
Winona, MN 55987
United States
507-457-5183 (Phone)
507-457-5697 (Fax)

Oscar Jorda

University of California, Davis - Department of Economics ( email )

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Davis, CA 95616-8578
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530-5549382 (Phone)

HOME PAGE: http://old.econ.ucdavis.edu/faculty/jorda/

Federal Reserve Banks - Federal Reserve Bank of San Francisco ( email )

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San Francisco, CA 94105
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HOME PAGE: http://www.frbsf.org/economic-research/economists/oscar-jorda/

Alan M. Taylor

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1572 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

University of Virginia - Department of Economics ( email )

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Charlottesville, VA 22904-4182
United States
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HOME PAGE: http://people.virginia.edu/~amt7u

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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