Productivity, Tradability, and the Long-Run Price Puzzle

Long-run cross-country price data exhibit a puzzle. Today, richer countries exhibit higher price levels than poorer countries, a stylized fact usually attributed to the “BalassaSamuelson” effect. But looking back fifty years, or more, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times. What might explain this historical pattern? We adopt a framework where goods are differentiated by tradability and productivity. A model with monopolistic competition, a continuum-of-goods, and endogenous tradability allows for theory and history to be consistent for a wide range of underlying productivity shocks. JEL code: F40, F43, N10, N70 Correspondence to: Alan M. Taylor tel: 530-752-1572 Department of Economics fax: 530-752-9382 University of California email: [email protected] One Shields Ave http://www.econ.ucdavis.edu/faculty/amtaylor/ Davis CA 95616-8578 * Taylor gratefully acknowledges the support of the Chancellor’s Fellowship at the University of California, Davis. We thank David Jacks, Alyson Ma, and Janine Wilson for excellent research assistance. For helpful comments we thank Stephen Broadberry, Nicholas Crafts, Robert Feenstra, Maurice Obstfeld, Mark Taylor, the NBER ITI group, and seminar participants at Claremont McKenna College, Columbia University, New York University University of California at Berkeley, University of California at Davis, University of Southern California, and the University of Texas. The views expressed below do not represent those of the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System. All errors are ours.