Abstract
•Historical data is used to look at the Balassa-Samuelson effect in the long run.•Large variations in the productivity effect are found across monetary regimes.•Variants of the traditional model with terms of trade mechanism are suggested.•Changes in trade costs over time may affect the impact of productivity over time.•Simulations show that plausible shifts in trade costs explain cross-regime variations.
Historical data for over hundred years and 14 countries is used to estimate the long-run effect of productivity on the real exchange rate. We find large variations in the productivity effect across four distinct monetary regimes in the sample period. Although the traditional Balassa-Samuelson model is not consistent with these results, we suggest an explanation of the results in terms of contemporary variants of the model that incorporate the terms of trade mechanism. Specifically we argue that changes in trade costs over time may affect the impact of productivity on the real exchange rate over time. We undertake simulations of the modern versions of the Balassa-Samuelson model to show that plausible parameter shifts consistent with the behavior of trade costs can explain the cross-regime variation of the productivity effect.