This paper advances the New Open Economy Macroeconomic literature in an empirical direction, estimating and testing a two-country model. Fit to U.S. and G7 data, the model performs moderately well for the exchange rate and current account. Results offer guidance for future theoretical work. Parameter estimates lend support to the assumption of local currency pricing. Estimates are found for key parameters commonly calibrated in the theoretical literature, such as the elasticity of substitution between home and foreign composite goods, and the response of a country's risk premium to the net foreign asset position. Results also indicate that deviations from interest rate parity are not closely related to monetary policy shocks, as recently hypothesized, but that these deviations are strongly related to shifts in the current account.

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for helpful comments. We thank Benjamin Mandel for superb research assistance. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. 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 Balassa-Samuelson effect. But looking back fifty years, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times, emerging a half century ago and growing steadily over time. What might potentially explain this historical pattern? We develop an updated Balassa-Samuelson model inspired by recent developments in trade theory, where a continuum of goods are differentiated by productivity, and where tradability is endogenously determined. Firms experiencing productivity gains are more likely to become tradable and crowd out firms not experiencing productivity gains. As a result the usual Balassa-Samuelson assumption-that productivity gains be concentrated in the traded goods sector-emerges endogenously, and the Balassa-Samuelson effect on relative price levels likewise evolves gradually over time. Abstract 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, this effect virtually disappears from the data. What is often assumed to be a universal property is actually quite specific to recent times, emerging a half century ago and growing steadily over time. What might potentially explain this historical pattern? We develop an updated Balassa-Samuelson model inspired by recent developments in trade theory, where a continuum of goods are differentiated by productivity, and where tradability is endogenously determined. Firms experiencing productivity gains are more likely to become tradable and crowd out firms not experiencing productivity gains. As a result the usual Balassa-Samuelson assumption-that productivity gains be concentrated in the traded goods sector-emerges endogenously, and the Balassa-Samuelson effect on relative price levels likewise evolves gradually over time. Terms of use: Documents inJEL code: F40, F43, N10, N70