This paper sets up a two-country two-sector dynamic stochastic general equilibrium model that introduces sector specific productivity shocks with quality improvement mechanism of goods. It provides a model-based theoretical background for the Harrod-Balassa-Samuelson phenomenon that describes the relationship between productivity and price inflation within different sectors in a particular economy. Both, the calibrated and the estimated model are able to show that the Harrod-Balassa-Samuelson effect is confirmed by inducing tradable sector productivity shocks as they drive the non-tradable sector price inflation higher than the tradable sector price inflation. By doing this, we overcome the problem that the tradable productivity increase in a typical open economy specification reduces the relative price of domestic tradable goods relative to the foreign ones.
Lenarčič, Č. (2019). Inflation – Harrod-Balassa-Samuelson Effect in a DSGE Model Setting. Economic and Business Review, 21(2). https://doi.org/10.15458/ebr.86