Testing the Harrod Balassa Sameulson Hypothesis: The Case of Pakistan.

Sunila Jabeen, Waseem Shahid Malik, Azad Haider

Abstract


For a small open economy of Pakistan, exchange rate is
determined through the two alternative theories; the nominal theory of
exchange rate named by Purchasing Power Parity (PPP) and the real theory
known as Harrod Balassa Sameulson (HBS). According to the requirements
of theories, two kinds of real exchange rate have been employed for the
yearly data of 1972-2008. As, both of the theories are disputed at the
ground of their long run relationship with real exchange rate,
therefore, the VAR based Johenson Co-integration approach has been
utilised to see the long run relationships. PPP has shown less
satisfactory results either in its form of absolute version or relative
version. Because, real exchange rate in Pakistan is a non-stationary
process by Augmented Dickey Fuller unit-root test, predicting some
pushing force behind the non-tradable sector. While favouring the PPP in
tradable sector, the ADF and KPSS are indicating the presence of the HBS
in Pakistan. On the other hand, the analysis of the HBS through
co-integration is showing that relative productivity difference has an
opposite relationship with relative non-tradable sector prices and with
RER. However, the relationship between relative non-tradable sector
prices and RER is much stronger and according to the theory. So, there
have been incorporated some demand side and external factors to reduce
the mis-specification of the simple HBS model. Therefore, in the
extended HBS model, productivity difference, government consumption
expenditure, terms of trade and world oil prices are appreciating the
RER and money supply (a control variable) is pursuing depreciation in
RER. So, these results yield some policy implications for Pakistan which
can be useful for developing countries as well. JEL classification: E0,
E31, E44 Keywords: Harrod-Balassa-Samuelson, Exchange Rate, Purchasing
Power Parity, Pakistan

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DOI: https://doi.org/10.30541/v50i4IIpp.379-399

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