Using the MSE decomposition technique, Engel (1999) found that real exchange rate changes between the US and the UK are accounted for mainly by tradables price changes. He re-ported that no Balassa-Samuelson effect in real exchange rate changes is det...
Using the MSE decomposition technique, Engel (1999) found that real exchange rate changes between the US and the UK are accounted for mainly by tradables price changes. He re-ported that no Balassa-Samuelson effect in real exchange rate changes is detected in real data. However, we argue that Engel's findings are because the US and the UK do not have large enough sectoral productivity differentials as the Balassa-Sarnuelson effect requires. Using the monthly data from january 1985 through February 2007 for a country pair of the US and Korea as well as from january 1980 through February 2007 for another country pair of the US and japan, we measured and compared the MSE shares of non-tradables price changes in real exchange rate changes. We found a clear difference in the movements of non-tradables price changes between the two pairs: first, the MSE shares of non-tradables price changes in the real exchange rate changes between the US and Korea were two times greater than those between the US and japan from january 1985 through September 1995 when Korea experienced more rapid growths in the tradable sector than in the non-tradable sector in comparison with between the US and japan. After September 1995 when the Korean relative growth in the tradable sector narrowed down toward those of the US and japan, the MSE shares of non-tradables price changes in real exchange rate changes between the US and Korea also became smaller in line with those between the US and japan. We conclude that there exists a Balassa-Samuelson effect in the real exchange rate change although it may constitute a small part of the real exchange rate change.