Investigating the Balassa-Samuelson Hypothesis in the Transition : Do We Understand What We See? A Panel Study

This paper studies the Balassa-Samuelson (B-S) effect in the Czech Republic, Hungary, Poland, Slovakia and Slovenia. We use time series and panel cointegration techniques and show that the B-S effect works reasonably well in the transition economies under study during the period from 1991:Q1 to 2001:Q2. However, we find, that productivity growth does not fully translate into price increases because of the construction of the CPI indexes. We therefore argue that productivity growth will not hinder meeting the Maastricht criterion on inflation in the medium term. In addition, the observed appreciation of the CPI-deflated real exchange rate is found to be systematically higher compared with the real appreciation the B-S effect could justify, especially in the cases of the Czech Republic and Slovakia. This can be partly explained by the trend appreciation of the tradable price-based real exchange rate, increases in non-tradable prices due to price liberalization and demand-side pressures and the evolution of the nominal exchange rate determined by the nature of the exchange rate regime and the magnitude of capital inflows