CEPII, Recherche et Expertise sur l'economie mondiale
Deviations in real exchange rate levels in the OECD countries and their structural determinants

Martin Berka
Daan Steenkamp

 Highlights :
  • We construct an annual panel of levels of real exchange rates, sectoral levels of total factor productivity, and measures of labour market institutions, for 17 OECD countries between 1970 and 2012. This data allows us to make meaningful cross-sectional comparisons in any given year.
  • We expand an augmented model of Balassa-Samuelson with labour market unionization rates that vary by sector, which allows the model to offer an extra avenue for non-productivity-related labour supply effects to cause changes in the real exchange rates. In this model, as in its predecessor due to Berka, Devereux and Engel (2018), differences in the unit labour costs act to capture some of the unobserved labour wedges which are orthogonal to productivity.
  • We estimate the solution of the model using our constructed data, and find that the augmented Balassa-Samuelson model is supported by our level panel data. That is, improvements in traded (nontraded) TFP levels, increases in relative ULC, and increases in sectoral wage markups due to labour market institutions appreciate (depreciate) real exchange rates.
  • We discuss the residual unexplained real exchange rates in our data. We find that large and persistent differences in real exchange rates remain after we control for the aforementioned supply-side considerations, indicating misalignment of RER in our sample of countries.

 Abstract :
We study the validity of an augmented Balassa-Samuelson theory in a panel of real exchange rate levels across 17 OECD countries between 1970 and 2012 using a unique panel of levels of total factor productivity (TFP) across sectors. We find that real exchange rates can be explained by relative sectoral TFP levels both across countries and over time in the direction predicted by Balassa-Samuelson hypothesis. We also show that drivers of labour wedges such as structural labour market differences are important in explaining real exchange rate levels. Nevertheless, large average conditional deviations in real exchange rate levels remain across countries in our sample.

 Keywords : Balassa-Samuelson | Real Exchange Rates | OECD | Total Factor Productivity | Labour Wedge | Unit Labour Cost

 JEL : E12, E23, E24, F31, F33, F41, F43
CEPII Working Paper
N°2018-16, September 2018

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 Fields of expertise

Money & Finance