Productivity Differential and Bilateral Real Exchange Rate between India and US

Soubarna Pal

Journal of Quantitative Economics, 2011, vol. 9, issue 1, 146-155

Abstract: Using annual data for 1959-2001 for India and USA, we test for the presence of real effects on the equilibrium real exchange rate (the Harrod Balassa Samuelson effect) in a non-linear framework. The real exchange rate is modelled as an exponential smooth transition autoregressive (ESTAR) process where we model the equilibrium real exchange rate as dependent upon differences in real income per capita. We find that higher productivity growth in US is accompanied by appreciation of its real exchange rate vis-a-vis India. We find significant evidence of non-linear mean reversion towards the long run equilibrium. We analyse the non-linear impulse response functions and find the evidence of faster mean reversion with larger shocks.

Date: 2011
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