When PPP holds, the Balassa-Samuelson forecast is:
A) very useful in predicting real and nominal exchange rate changes.
B) somewhat useful except that traders are often unpredictable.
C) not useful because when PPP holds, the real exchange rate is equal to 1.
D) used only for comparisons between low-income nations.

Question

Quizplus · Accepted Answer

When PPP holds, the Balassa-Samuelson effect states that the only source of differences in the price level between nations is the differences in productivity levels, which affects only the traded goods sector. Therefore, PPP would imply that the real exchange rate is equal to 1 and the Balassa-Samuelson forecast is not useful in predicting real and nominal exchange rate changes.

When PPP Holds, the Balassa-Samuelson Forecast Is