4/2003 Balázs Égert. Nominal and real convergence in Estonia: The Balassa-Samuelson (dis)connection tradable goods, regulated prices and other culprits

Working Papers of Eesti Pank. No 4, 2003

The objective of the paper is to analyse the nominal and real convergence process in Estonia drawing on the Balassa-Samuelson (B-S) framework. A 15-sectoral breakdown for GDP and a 5-digit level CPI data disaggregation with over 260 items is used for the period 1993:Q1 to 2002:Q1 to show that the productivity differential is related to the GDP-deflator relative price of non-tradable goods in the long run. Furthermore, the role of regulated prices in the CPI basket is also investigated - we show that excluding regulated prices makes it possible to detect a robust relationship between productivity and the relative price of market services in CPI. The B-S effect could have possibly contributed to CPI by a yearly average of 2-3% over the sample period, and more specifically 1-4% at the beginning of the period and 0.5-1% in 2000 and 2001. The potential long-run impact of the B-S effect in Estonia is estimated to amount to 1-2%. Analysis of the influence of the B-S effect on the inflation differential and the real appreciation of the exchange rate against Finland, Sweden, Germany and the UK, shows that, whereas the inflation differential attributable to the B-S effect seems to have been higher in the early 1990s, it better explains the real appreciation occurring in recent years.

 

Keywords: convergence, transition, Balassa-Samuelson effect, productivity, relative prices, tradable goods, regulated prices, real exchange rate

Author's e-mail address: begert [at] u-paris10.fr

The views expressed are those of the author and do not necessarily represent the official views of Eesti Pank.

Europe Economics, London, UK and University of Paris X - Nanterre, France. This study was undertaken at the Bank of Estonia where the author spent 6 weeks as a visiting researcher.
The paper has benefited from discussion at seminars at the Bank of Estonia and in BOFIT (Bank of Finland). The author would like to thank, without implicating them, Abdur Chowdury, Ülo Kaasik, Iikka Korhonen, Kirsten Lommatzsch, Martti Randveer, Marit Rõõm, Karsten Staehr and Pekka Sutela for useful remarks and suggestions. The author is also grateful to Magnus Andersson, Luca Benati, Ulf von Kalckreuth, Rafal Kierzenkowski, Iikka Korhonen, Kirsten Lommatzsch, Tuomas Rothovius, Mari Tamm, Udd Toni and Natalja Viilmann for their help in obtaining the data used in the paper.

TABLE OF CONTENTS

I. Introduction
II. The The Balassa-Samuelson framework
III. Methodological overview of the literature on the B-S effect
III.A. The B-S effect in CEECs
III.B. The B-S effect in Estonia: The lack of empirical studies
IV. Data definitions
IV.A. The productivity series
IV.B. The relative price series
IV.C. The real exchange rate series
V. A preliminary data analysis
VI. Are the basic assumptions of the model fulfilled?
VII. The econometric approach
VIII. Results
VIII.A. How strong is the relationship between the productivity differential and relative prices in Estonia?
VIII.B. The difference between the productivity differential, relative prices and the real exchange rate
IX. Descriptive statistics: A routine exercise
IX.A. Structural inflation in Estonia
IX.B. The structural inflation differential vis-à-vis the benchmark countries
IX.C. The appreciation of the real exchange rate
X. Concluding remarks
References
Appendix 1. Data sources
Appendix 2. Data
Appendix 3. Testing strategies
Appendix 4. Unit root tests
Appendix 5. Diagnostic tests for the cointegration analysis

Nominal and Real Convergence in Estonia: The Balassa-Samuelson (Dis)connection. Tradable Goods, Regulated Prices and Other Culprits, Working Papers of Eesti Pank, No 4, 2003 (PDF*)

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