Real exchange rate, productivity and labor market frictions

Yu Sheng, Xinpeng Xu

    Research output: Contribution to journalArticle


    We extend the classic Balassa-Samuelson model to an environment with search unemployment. We show that the classic Balassa-Samuelson model with the assumption of full employment emerges as a special case of our more generalized model. In our generalized model, the degree of labor market matching efficiency affects the strength of the structural relationship between the real exchange rate and sectoral productivity through influencing labor's choice between employment and unemployment as well as movement across sectors. When the relative labor market matching friction is high, search unemployment is high and the standard Balassa-Samuelson effect may not hold. Empirical evidence supports our theory: controlling for differences in labor market frictions across countries provides a better fit in estimating the Balassa-Samuelson effect.
    Original languageEnglish
    Pages (from-to)587-603
    JournalJournal of International Money and Finance
    Issue number3
    Publication statusPublished - 2011


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