Assessment of BalassaSamuelson Effect in Croatia

1

• Assessment of Balassa-Samuelson Effect in Croatia
• by
• Josip Funda, Gorana Lukinic, Igor Ljubaj
• Discussant K. igic
• Prague, Czech Republic

2
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

3
BS effectDomestic versus international BS effect

• a. Simple Accounting Framework
• Domestic BS effect
  BSd ß1(?PRODT
  T - ?PRODNT NT)
• Inflation BS (1-a) ß1(?PRODT T - ?PRODNT
  NT)
• International BS effect
  BSm ?p -
  ?p ß2 (1-a) (?PRODT T- ?PRODNT NT) (1-a)
  (?PRODTT - ?PRODNTNT )
  Negative BS effect in the period
  1999-2006!
  (lower share of non-tradables in Croatia versus
  EU 41 versus 23 respectively)

4

• b. Econometric Analysis
• Domestic BS effect
• ? log(CPINT/ CPIT )t c ß0 ? log(LPNT /LPT )t
  ei
• ß0 not significant in any of the two
  specifications
• International BS effect
• ? log RERt c ß0 ?prod _ dif ei
• ? log(CPI/ CPIEA )t c ß0 ?prod _dif ß1 ?Et
  ei
• ß0 and ß1 not significant in any of the two
  specifications!

5
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!

6
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?

7
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.

8
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!

9
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

10
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)

11
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).

12
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.)

13
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.