Transcript Slide 1

Assessment of Balassa-Samuelson Effect in Croatia
by
Josip Funda, Gorana Lukinić, Igor Ljubaj
Discussant: K. Žigić
Prague, Czech Republic
Research questions

Assessment of the importance of the
Balassa-Samuelson (BS) effect in Croatia
and quantify its influence on inflation and
the real exchange rate
BS effect
Domestic versus international BS effect
a. Simple Accounting Framework
Domestic BS effect:
BSd = β1(ΔPRODT T − ΔPRODNT NT)
Inflation BS = (1-α) β1(ΔPRODT T − ΔPRODNT NT)
International BS effect:
BSm = Δp − Δp* = β2 [(1-α) (ΔPRODT T− ΔPRODNT NT) –
(1-α*) (ΔPRODTT* − ΔPRODNTNT* )]
Negative BS effect in the period 1999-2006!
(lower share of non-tradables in Croatia versus EU; 41% versus
23% respectively)
b. Econometric Analysis
Domestic BS effect:
Δ log(CPINT/ CPIT )t = c + β0 Δ log(LPNT /LPT )t + εi
β0 not significant in any of the two specifications
International BS effect:
Δ log RERt = c + β0 Δprod _ dif + εi
Δ log(CPI/ CPIEA )t = c + β0 Δprod _dif + β1 ΔEt +εi
β0 and β1 not significant in any of the two specifications!
Comments, suggestions, questions
1) The analysis follows closely the
approach and methodology developed by
Mihaljek and Klau (2003) but focus on
Croatia.
(Section 2. pages 5-8, “Theoretical
Background” taken almost whole from
Mihaljek and Klau (2003)) .
Fine but please acknowledge it!
Comments, suggestions, questions
2) Be more ambitious!
Compare the BS effect and real appreciation in Croatia
with that of other relevant countries (Slovenia, Hungary,
Czech Republic)! Why Croatia (and perhaps) Slovenia
are different than the other transition economies?
Comments, suggestions, questions
3) Explore investment in quality (and product
variety) effect that lead to real appreciation!
Divergence even in prices of tradables of
transition countries vis-à-vis its EU trading
partners in PPP terms.
Comments, suggestions, questions
4) Review some stylized facts in CEEC
countries!
* Quality improvements play a role among determinants
of real exchange rate appreciation of transition
economies; (See Broeck and Slok, 2006, Egert and
Lommatzsch, 2004)
* Quality improvements are not accounted for by the
statistical offices in transition economies
*Quality bias of consumer price index!
Comments, suggestions, questions
Point 4) continued
For instance, the inflation overstatement as high as 5 percentage points a year
in the first decade of economic transformation in the Czech Republic (see
for instance Hanousek and Filer, 2004).
Quality-unadjusted price indexes might be well responsible for a substantial
part of the pace of the real exchange rate development in a transition
economy.
FDI and real exchange rate appreciation! (FDI are to large extent directed to
export oriented industries, which had an effect on improvements in quality
of products e.g. due to competition pressures in tradable goods markets
worldwide).
High correlation of the size of the direct investment inflow with the size of the
real appreciation of the local currency
Comments, suggestions, questions
5) Check for terms of trade in Croatia in the
period under considerations!
(Improvement in terms of trade may mirror the quality
improvement, particularly if at the same time a physical
volume of export increases)
Comments, suggestions, questions
6) Look at the new international macro
literature (NIM) for inspiration!
(Typical features of the NIM framework are
monopolistic competition, ex post heterogeneity of
production entities due to uncertain post- entry
productivity, role of sunk costs and self-selection in
trade. See Melitz, 2003 and especially Ghironi and
Melitz, 2005 and Bruha and Podpiera, 2007).
Comments, suggestions, questions
Point 6) continued
NIM provides a sound micro- foundation for BS effect!
In particular the findings from the NIM type model (see Bruha and Podpiera
2007) indicates that quality investment and creation of new varieties might
be responsible for the observed significant real exchange rate appreciation,
that often remains unexplained by prevailing models.
Convergence of countries facilitated by an extensive growth might be
compatible with stability of real exchange rate, while countries pursuing
intensive growth and convergence exhibit significant real exchange rate
appreciation.
Implications for the Maastricht criteria
(Countries with significant real appreciation will be in conflict in jointly fulfilling
the exchange rate and inflation stability criteria.)
References:
1.) Bruha, J and Podpiera, (2007). Bruha, J and Podpiera, (2007). Transition economy
convergence in a two-country model – implications for monetary integration, Working
Paper Series 740, European Central Bank.
2.) De Broeck, M., T. Slok, (2006). Interpreting Real Exchange Rate Movements in
Transition Countries. Journal of International Economics 68, pp.368-383.
3.) Egert, B., K. Lommatzsch (2004). Equilibrium Exchange Rates in the Transition: The
Tradable Price-based Real Appreciation and Estimation Uncertainty. William Davidson
Institute WP 676.
4.) Ghironi, F., Melitz M. (2005). International Trade and Macroeconomic Dynamics with
Heterogeneous Firms. Quarterly Journal of Economics, CXX
(August 2005), pp. 865-915.
5.) Hanousek J., R. Filer (2004). Consumers’ Opinion of Inflation Bias Due to Quality
Improvements. William Davidson Institute WP 681.
6.) Melitz, M. (2003). The Impact of Trade on Intra-Industry Reallocation and Aggregate
Industry Productivity. Econometrica 71/6, pp. 1695-1725.
7.) Mihaljek, D., M. Klau (2003). The Balassa - Samuelson effect in central Europe: a
disaggregated analysis, BIS Working Paper 143.