Are proxies of Balassa-Samuelson effect robust? Evidence from developing countries

Abstract

Exchange rate movements have started achieving a pivotal role in shaping economic expectations of a common man in today’s world. These variations which once used to be regular oscillations between currencies in the world market have gradually become the real drivers of change of the macroeconomic fundamentals in every economy. On the one hand, the daily changes in these rates impact the consumption and investment decisions of the individuals while their deviation from a perceived rather calculated normal steers action from the governments on the other, in order to control other connected macroeconomic indicators including inflation, investment, exports, imports etc. The evidence suggests that no matter how deviated these the real exchange rates between two countries may be, there exist tacit drivers that pull them back to converge to a similar pattern over time to the least. Despite evidence on convergence of real exchange rates, the studies that aim to investigate the determinants of equilibrium exchange rate find scant or at least inconclusive evidence in favour of Balassa Samuelson hypothesis (and hence purchasing power parity) as being a determinant of real exchange rate (or equilibrium real exchange rate)...