Japan's inflation under the Bretton Woods system: How large was the Balassa-Samuelson effect?

Japan's real exchange rate appreciation during the post-WWII manufacturing-led growth period has been regarded as a classical example of the Balassa-Samuelson effect. We choose the most conspicuous sub-period--1956-1970--to confirm the effect. Japan was in a rapid growth period under the U.S. dollar peg (real GDP growth, 9.7% per annum). The nominal anchor was weak as Japan's inflation rate (GDP deflator-based, 5.4%) was markedly higher than the U.S. rate (2.6%) during the 15-year period. The decomposition of the annual 2.7% (geometric) Japan-U.S. inflation rate gap (real exchange rate appreciation of the Japanese yen) reveals that the Balassa-Samuelson effect accounted for 0.7%; most of the real exchange rate appreciation (1.7%) was attributed to greater price increases in Japan's tradables. Although Japan's tradable sector achieved high TFP growth, the joint effect of the tradable-nontradable TFP growth difference between the two economies was too small to generate a sizable Balassa-Samuelson effect. Japan's example may suggest that even in rapidly growing economies, the magnitude of the effect in long-run real exchange rate appreciation is generally modest.