DP4494 Productivity, Tradability and the Long-Run Price Puzzle

Author(s): Paul R Bergin, Reuven Glick, Alan M. Taylor
Publication Date: July 2004
Keyword(s): great divergence, real exchange rate, Ricardo-Harrod-Balassa-Samuelson effect
JEL(s): F40, F43, N10, N70
Programme Areas: International Macroeconomics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4494

Long-run cross-country price data exhibit a puzzle. Today, richer countries exhibit higher price levels than poorer countries, a stylized fact usually attributed to the ‘Balassa-Samuelson’ effect. But looking back 50 years, or more, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times. What might explain this historical pattern? We adopt a framework where goods are differentiated by tradability and productivity. A model with monopolistic competition, a continuum-of-goods, and endogenous tradability allows for theory and history to be consistent for a wide range of underlying productivity shocks.