DP4494 | Productivity, Tradability and the Long-Run Price Puzzle

Publication Date

23/07/2004

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Abstract

Long-run cross-country price data exhibit a puzzle. Today, richer countries exhibit higher price levels than poorer countries, a stylized fact usually attributed to the ?Balassa-Samuelson? effect. But looking back 50 years, or more, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times. What might explain this historical pattern? We adopt a framework where goods are differentiated by tradability and productivity. A model with monopolistic competition, a continuum-of-goods, and endogenous tradability allows for theory and history to be consistent for a wide range of underlying productivity shocks.