Testing the Balassa-Samuelson Hypothesis: Evidence from 10 OECD Countries

Abstract: This study tests the Balassa-Samuelson (BS) hypothesis for 10 OECD countries between 1975 and 2007 using the recent data sets and econometric methods. The study employs the Johansen cointegration approach in country-specific analysis. To investigate the existence of cointegration in panel series Pedroni, Kao and Johansen-Fisher tests of panel cointegration are used. The country-specific and panel cointegration test results confirm the existence of cointegration among the real effective exchange rate, relative productivity and terms of trade. And the country-specific coefficient estimations put evidence in favor of the BS hypothesis, except USA, and Japan. On the other hand, the panel estimation results could not confirm the validity of the BS hypothesis due to wrong sign of the BS effect. In a nutshell, the study’s major findings suggest that the BS hypothesis still works well in OECD countries while explaining the long-run movements of the real effective exchange rates.