# Another Prospective on Real Exchange Rate and the Traded Goods Prices: Revisiting Balassa–Samuelson Hypothesis

^{1}

^{2}

^{*}

## Abstract

**:**

## 1. Introduction

## 2. Theoretical Background of PPP and BS Effects

## 3. Literature Review

## 4. Econometric Methodology and Model Specifications

#### Empirical Verification of Purchasing Power Parity Assumption for InterCountry Traded-Sector Prices

**C1.**In the long run, home prices of tradables should comove with their foreign counterpart.

**C2.**Home prices bear a direct and equi-proportionate relationship with their foreign counterpart.

## 5. Results and Discussions

#### Empirical Verification of the Relaxed Version of Balassa–Samuelson Hypothesis

- S1. Residual-Based Single-Equation Cointegration Test:

- S2. Estimating the Error Correction Model (ECM):

**M1.**Maximum-Likelihood-Based Rank Test of Cointegration: The condition for establishing a cointegrating relationship under this model comes [50,51,52] ML cointegration procedure. As this is a system of equations, it allows the possibility of more than one cointegrating vector. The existence of valid cointegration is detected using the Trace and Maximum Eigenvalue statistics. Given the rank of the test $\left(r\right)$ and the number of model variables $\left(n\right),$ the valid cointegration necessitates that $0\le {r}^{*}<n$. The Trace test tests the null hypothesis of no more than ${r}^{*}$ cointegrating vectors against the alternative hypothesis of more than ${r}^{*}$ cointegrating vectors. The Maximum Eigenvalue test, on the other hand, tests the null hypothesis of ${r}^{*}$ cointegrating vectors against the alternative hypothesis of ${r}^{*}+1$ vectors.

**M2.**Vector Error Correction (VEC) Model and Test for Exogeneity: Similar to the single-equation error correction model, the VEC estimator may entail an error adjustment process, under the system of equation approach. Valid cointegration between $re{r}^{NT}$ and its determinants requires that the error correction coefficient in the $rer$ equation $\left(E{C}_{rer}\right)$ is negative and statistically significant.

- (i)
- At least two of P1.A, P1.B, and P1.C;
- (ii)
- Both P2.A and P2.B hold valid.

- (i)
- At least two of P1.A, P1.B, and P1.C;
- (ii)
- P2.A or P2.B (but not both) hold valid.

## 6. Concluding Remarks

## Author Contributions

## Funding

## Institutional Review Board Statement

## Informed Consent Statement

## Data Availability Statement

## Conflicts of Interest

## References

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$\mathbf{C}1\u2014\mathbf{Establishing}\mathbf{Cointegration}\phantom{\rule{0ex}{0ex}}(\mathbf{FMOLS}\mathbf{and}\mathbf{DOLS})\phantom{\rule{0ex}{0ex}}{\mathit{p}}_{\mathit{t}}^{\mathit{T}}=\mathit{\gamma}+\mathit{\theta}\left({\mathit{e}}_{\mathit{t}}+{\mathit{p}}_{\mathit{t}}^{\mathit{T}*}\right)+{\mathit{\epsilon}}_{\mathit{t}}\phantom{\rule{0ex}{0ex}}{\mathit{H}}_{1}:\mathit{C}\mathit{o}\mathit{i}\mathit{n}\mathit{t}\mathit{e}\mathit{g}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathit{n}\mathit{E}\mathit{x}\mathit{i}\mathit{s}\mathit{t}\mathit{s}\phantom{\rule{0ex}{0ex}}\mathit{\theta}\mathit{is}\mathit{Statistically}\mathit{Significant}$ | $\mathbf{C}2\u2014\mathbf{Testing}\mathbf{for}\mathbf{EquiProportionate}\mathbf{Relationship}\phantom{\rule{0ex}{0ex}}(\mathbf{Wald}\mathbf{Coefficient}\mathbf{Test})\phantom{\rule{0ex}{0ex}}{\mathit{H}}_{0}:\widehat{\mathit{\theta}}=1\phantom{\rule{0ex}{0ex}}{\mathit{H}}_{0}$$:\mathbf{EquiProportionate}\mathbf{Relationship}\mathbf{between}{\mathit{p}}^{\mathit{T}}$$\mathbf{and}\mathit{e}+{\mathit{p}}^{\mathit{T}*}$ | Is Estimation of Modified BS Model Permissible? |
---|---|---|

$\mathrm{Yes}\u2014\mathrm{Absolute}\mathrm{support}\mathrm{for}{H}_{1}$ | $\u2018\mathrm{YES}\u2019\mathrm{absolute}\mathrm{support}\mathrm{for}{H}_{0}$ | No |

$\u2018\mathrm{MIXED}\u2019\mathrm{support}\mathrm{for}{H}_{0}$ | Yes | |

$\u2018\mathrm{NO}\u2019\mathrm{support}\mathrm{for}{H}_{0}$ | Yes | |

$\mathrm{Mixed}\mathrm{support}\mathrm{for}{H}_{1}$ | $\u2018\mathrm{YES}\u2019\mathrm{absolute}\mathrm{support}\mathrm{for}{H}_{0}$ | No |

$\u2018\mathrm{MIXED}\u2019\mathrm{support}\mathrm{for}{H}_{0}$ | Yes | |

$\u2018\mathrm{NO}\u2019\mathrm{support}\mathrm{for}{H}_{0}$ | Yes | |

$\mathrm{No}\mathrm{support}\mathrm{for}{H}_{1}$ | NA | Yes |

Country | S1—Establishing Cointegration Cointegration Regression Estimates | S2—Testing for Equiproportionate Relationship F-Statistics from Wald Test | Does PPP Hold for Tradables’ Prices? | ||
---|---|---|---|---|---|

FMOLS | DOLS | FMOLS | DOLS | ||

Indonesia (1976–2018) | 1.03 [16.62] | 1.00 [15.01] | 0.21 (0.65) | 0.00 (0.99) | Yes |

Japan (1970–2018) | 0.04 [0.20] | 0.07 [0.30] | - | - | No |

Korea (1973–2018) | 1.38 [24.95] | 1.33 [25.30] | 47.84 (0.00) | 28.03 (0.00) | No |

Malaysia (1981–2018) | 1.01 [5.84] | 1.02 [5.58] | 0.03 (0.97) | 0.10 (0.92) | Yes |

Pakistan (1973–2018) | 0.89 [23.13] | 0.86 [24.69] | 7.33 (0.01) | 15.12 (0.00) | No |

Philippines (1971–2018) | 1.10 [34.35] | 1.06 [34.38] | 3.03 (0.00) | 2.10 (0.04) | No |

Singapore (1970–2018) | 1.90 [4.43] | 1.72 [3.81] | 2.10 (0.04) | 1.59 (0.12) | Mixed |

Sri Lanka (1980–2018) | 1.19 [19.28] | 1.09 [14.51] | 3.06 (0.00) | 1.24 (0.23) | Mixed |

Thailand (1971–2018) | 1.32 [13.62] | 1.24 [12.48] | 3.34 (0.00) | 2.43 (0.02) | No |

Country | Single-Equation Cointegration Approach | LR Coefficients Obtained through Cointegration Regression | Does BS Effect Hold? | ||||
---|---|---|---|---|---|---|---|

Are EG Test Residuals I(0)? | EC Coefficient | FMOLS | DOLS | ||||

$\tilde{\mathit{a}}=\mathit{B}\mathit{S}\mathit{C}\mathit{o}\mathit{e}\mathit{f}\mathit{f}\mathit{i}\mathit{c}\mathit{i}\mathit{e}\mathit{n}\mathit{t}$ | $\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{t}$ | $\tilde{\mathit{a}}=\mathit{B}\mathit{S}\mathit{C}\mathit{o}\mathit{e}\mathit{f}\mathit{f}\mathit{i}\mathit{c}\mathit{i}\mathit{e}\mathit{n}\mathit{t}$ | $\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{t}$ | ||||

Japan (1970–2018) | No | −0.02 [−0.09] | - | - | - | - | No |

Korea (1970–2018) | No | −0.27 [−2.26] | −0.11 [−1.90] | 0.63 [2.57] | −0.09 [−1.06] | 0.63 [1.49] | No |

Pakistan (1973–2018) | No | −0.09 [−1.73] | −0.14 [−0.32] | 1.59 [3.46] | 2.43 [2.16] | 3.67 [3.91] | Mixed |

Philippines (1971–2018) | No | −0.20 [−2.04] | 0.37 [2.60] | 1.03 [3.17] | 0.58 [2.46] | 1.27 [2.31] | Yes |

Singapore (1970–2018) | No | 0.05 [1.15] | - | - | - | - | No |

Sri Lanka (1981–2018) | No | −0.07 [−0.26] | - | - | - | - | No |

Thailand (1971–2018) | No | −0.09 [−1.12] | - | - | - | - | No |

Country | Multivariate Cointegration Approach | Vector Error Correction Model (VECM) | Does BS Effect Hold? | ||||||
---|---|---|---|---|---|---|---|---|---|

Case 3 of VECM | Case 4 of VECM | ||||||||

Trace Statistics (Case 3/Case 4) | Max Eigenvalue (Case 3/Case 4) | $\mathit{E}{\mathit{C}}_{\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{n}\mathit{t}}$ | $\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{t}$ | $\tilde{\mathit{a}}\phantom{\rule{0ex}{0ex}}\left(\mathrm{BS}\mathrm{Coefficient}\right)$ | $\mathit{E}{\mathit{C}}_{\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{n}\mathit{t}}$ | $\mathit{r}\mathit{e}\mathit{r}\_\mathit{d}\mathit{e}\mathit{f}\_\mathit{t}$ | $\tilde{\mathit{a}}\phantom{\rule{0ex}{0ex}}\left(\mathrm{BS}\mathrm{Coefficient}\right)$ | ||

Japan (1970–2018) | 0/0 | 0/0 | - | - | - | - | - | - | No |

Korea (1970–2018) | 1/0 | 1/0 | 0.00 [1.20] | 66.31 [3.43] | −7.51 [−1.77] | - | - | - | No |

Pakistan (1973–2018) | 1/1 | 1/0 | −0.00 [−0.33] | 10.36 [5.80] | 10.76 [5.17] | −0.08 [−1.13] | 2.38 [7.18] | 1.94 [5.56] | No |

Philippines (1971–2018) | 0/0 | 0/0 | - | - | - | - | - | - | No |

Singapore (1970–2018) | 0/0 | 0/0 | - | - | - | - | - | - | No |

Sri Lanka (1981–2018) | 0/1 | 0/0 | - | - | - | −0.05 [−0.85] | 1.09 [2.28] | −1.93 [−4.10] | No |

Thailand (1971–2018) | 1/0 | 1/0 | −0.02 [−1.50] | 6.21 [5.29] | −2.22 [−4.31] | - | - | - | No |

**Table 5.**Summary of Results for Panel Unit Root and Cointegration Tests for Modified Balassa–Samuelson Hypothesis.

Panel Unit Root Test Results (Order of Integration as Determined by) | ||||
---|---|---|---|---|

Variables | Fisher-ADF | Fisher-PP | Hadri | Conclusion |

${p}^{T}$ | I(0) *** | I(0) *** | Greater than I(1) | I(0) |

$e+{p}^{T}$ | I(1) *** | I(1) *** | I(1) *** | I(1) |

$rer\_def\_nt$ | I (0) * | I (1) *** | I (1) *** | I (1) |

$rer\_def\_t$ | I (1) *** | I (1) *** | I (1) *** | I(1) |

$\tilde{a}$ | I (0) ** | I (0) ** | Greater than I (1) | I(0) |

Testing for Tradables’ PPP (t-ratios and p-values are given in square brackets and parentheses, respectively.) | ||||

P1. Testing for Cointegration | P2. Testing for Equiproportionate Relationship(F-Statistics from Wald Coefficient Test) | Does PPP Hold for Tradables’ Prices? | ||

PFMOLS | PDOLS | PFMOLS | PDOLS | Mixed |

1.08 | 1.01 | 7.25 | 0.06 | |

[37.73] | [34.49] | (0.01) | (0.80) |

Pedroni Panel Cointegration Test Results | |||||||
---|---|---|---|---|---|---|---|

Common AR Coefficients (Within Dimension) | Individual AR Coefficients (Between Dimension) | ||||||

Panel v Statistics | $\mathbf{Panel}\mathsf{\rho}$ Statistics | Panel PP Statistics | Panel ADF Statistics | $\mathbf{Group}\mathsf{\rho}$ Statistics | Group PP Statistics | Group ADF Statistics | Does BS Effect Hold? |

−0.13 | 1.96 | 2.10 | 1.33 | 2.00 | 1.30 | 0.65 | No |

Johansen–Fisher Panel Cointegration Test Results (lag selection is done through SIC under panel VAR). | |||||||

Case 3: Intercept (no trend) in cointegrating equation and VAR | |||||||

Fisher Stat (From Trace Stat) | Fisher Stat (From Max Eigenvalue) | Does BS Effect Hold? | |||||

1 | 1 | See below | |||||

Case 4: Intercept and trend in cointegrating equation—no trend in VAR | |||||||

1 | 1 | See below |

**Table 7.**Estimating the Long-Run Cointegrating Vectors for the Modified Balassa–Samuelson Hypothesis.

Results for Panel FMOLS and DOLS (Lead = Lag = 1) Estimators | |||
---|---|---|---|

Estimator | Long-Run Coefficient (t-Values Are Given in Square Brackets) | Does BS Effect Hold? | |

PFMOLS | $rer\_def\_t$ | $\tilde{a}=BSCoefficient$ | No |

0.30 [2.70] | −0.13 [−2.87] | ||

PDOLS | 0.27 [1.88] | −0.12 [−2.24] | No |

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## Share and Cite

**MDPI and ACS Style**

Ishaq, M.; Ghouse, G.; Bhatti, M.I.
Another Prospective on Real Exchange Rate and the Traded Goods Prices: Revisiting Balassa–Samuelson Hypothesis. *Sustainability* **2022**, *14*, 7529.
https://doi.org/10.3390/su14137529

**AMA Style**

Ishaq M, Ghouse G, Bhatti MI.
Another Prospective on Real Exchange Rate and the Traded Goods Prices: Revisiting Balassa–Samuelson Hypothesis. *Sustainability*. 2022; 14(13):7529.
https://doi.org/10.3390/su14137529

**Chicago/Turabian Style**

Ishaq, Maryam, Ghulam Ghouse, and Muhammad Ishaq Bhatti.
2022. "Another Prospective on Real Exchange Rate and the Traded Goods Prices: Revisiting Balassa–Samuelson Hypothesis" *Sustainability* 14, no. 13: 7529.
https://doi.org/10.3390/su14137529