Prices and the Real Exchange Rate in Hong Kong: 1985-2006

Abstract

This paper seeks to quantify to the extent to which price dynamics in Hong Kong are due to the Balassa-Samuelson hypothesis. From 1985 to 1998, the CPI in Hong Kong increased spectacularly, yet there was dramatic deflation from 1998 to 2006. This dynamics was mainly driven by the price pattern of the nontradable goods and services. We find that, the Balassa-Samuelson hypothesis seems to be a good explanation for the inflation differentials between Hong Kong and the US from 1985 to 1998. However, in the 1998-2006 period, we find that the Balassa-Samuelson hypothesis cannot explain the inflation di¤erentials between Hong Kong and the US. On the one hand, there is a significant deviation from the PPP in the price of tradable goods between both countries. On the other hand, the internal transmission of the Balassa-Samuelson hypothesis does not hold for either country.