Abstract

In the purchasing power parity (PPP) literature, most studies do not take dynamics into account when they try to explain the deviation of PPP, and none use the Bayesian approach. This paper closes this gap by using the Bayesian dynamic linear model (DLM) to examine the German-US real exchange rate and test whether the Balassa-Samuelson effect explains the deviation from PPP. The results show that PPP does not hold during the period examined and the negative sign of the coefficient of German productivity differential between tradable and nontradable sectors and the positive effect of the productivity differential violate the assumption of the Balassa-Samuelson effect.

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