The Balassa-Samuelson Effect in Central and Eastern Europe: Myth or Reality?

Abstract

This paper studies the Balassa-Samuelson effect in nine Central and East European countries. Using panel cointegration techniques, we find that the productivity growth differential in the open sector leads to inflation in non-tradable goods. Because of the low share of non-tradables and the high share of food items in addition to regulated prices, the consumer price index is misleading when analyzing the Balassa-Samuelson effect. Consequently, the appreciation of the real exchange rate, which has been established as a stylized fact over the last decade, is caused only partly by the Balassa-Samuelson effect. We identify a trend increase in the prices of tradable goods as a contributing explanation.