Topic 9: The Balassa-Samuelson Hypothesis

Question 1

Show the real exchange rate equation if we are using tradeable & nontradeable goods, whose shares in the economy are the same in both economies, where prices are measured in the same currency, and the law of one price holds (for traded goods).

Answer 1

Question 2

If for two trading economies, A_N =A_N*

Labour arbitrage operating within the countries.

The home country is developing, the foreign developed (A_T < A_T*)

And the production functions are linear, show the wage conditions for both countries.

Answer 2

W_N = A_NP_N = W_T = A_TP_T

W_N* = A_NP_N* = W_T = A_TP_T*

Question 3

Show how the real exchange rate relates to relative wages between a developing & developed country in the Bellosa-Samuelson simple model. What does this imply for producitivity growth?

Answer 3

Tradeable productivity growth must cause a real appreciation

Question 4

What are the key assumptions of the Bellosa-Samuelson model? Are they plausible?

Answer 4

• Tradeable productivity gap; service producitity gap also
• Larbour arbitrage within coutnries; nope, see poverty in rural areas
• LOP; not too bad, but many supply & demand shocks affect e_R
• Closed capital account - clearly not the case

Question 5

What is essentual to include in a model of e_R

Answer 5

• Non-traded services
• Traded productes that are differenciated
• open capital accoutns
• Human capital
• Demographic change and how the Human capital changes
• Labour arbitrage limits

Question 6

How does an increase in productity increase relative to trading partners affect e_R

Answer 6

If uniform across sectors, home prices decrease, real depreciation

If faster in tradeable, tradeable expansion pushes up wages, pushing up prices in non-traded sectors. - Real Appreciation. (Balassa)

Question 7

How will factor accumulation, relative to other countries affect e_R

Answer 7

Generally causes reduced factor rewards, a real depreciation

If in non capital factors, an initial investment stimulus may cause a real appreciation, before the long run depreciation.

Question 8

How does trade liberalization affect the real exchagne rate?

Answer 8

Shifts demand away from home products, a real depreciation

Question 9

Hwo does a decline in interest premiums (financial reform) affect the e_R?

Answer 9

Short run; raises aggregate demand, real appreciation

Long run; raises cpaital stock, real depreciation.