Historical data for over hundred years and 14 countries is used to estimate the long-run effect of productivity on the real exchange rate. We find large variations in the productivity effect across four distinct monetary regimes in the sample period. Although the traditional Balassa-Samuelson model is not consistent with these results, we suggest an explanation of the results in terms of contemporary variants of the model that incorporate the terms of trade mechanism. Specifically we argue that changes in trade costs over time may affect the impact of productivity on the real exchange rate over time. We undertake simulations of the modern versions of the Balassa-Samuelson model to show that plausible parameter shifts consistent with the behavior of trade costs can explain the cross-regime variation of the productivity effect.

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Keywords Balassa-Samuelson model, Productivity, Real exchange rates, Terms of trade
Persistent URL dx.doi.org/10.1016/j.jimonfin.2017.03.011
Journal Journal of International Money and Finance
Bordo, M.D. (Michael D.), Choudhri, E.U, Fazio, G. (Giorgio), & MacDonald, R. (Ronald). (2017). The real exchange rate in the long run: Balassa-Samuelson effects reconsidered. Journal of International Money and Finance, 75, 69–92. doi:10.1016/j.jimonfin.2017.03.011