Relative labor productivity and the real exchange rate in the long run: evidence for a panel of OECD countries

The Balassa-Samuelson model, which explains real exchange rate movements in terms of sectoral productivities, rests on two components. First, it implies that the relative price of non-traded goods in each country should reflect the relative productivity of labor in the traded and non-traded goods sectors. Second, it assumes purchasing power parity holds for traded goods. We test both of these using a panel of OECD countries. Our results suggest that relative prices generally reflect relative labor productivities in the long run. The evidence on purchasing power parity in traded goods is less favorable, at least when we look at US dollar exchange rates.