The role of devaluation in stimulating profitability, investment, and ec onomic activity is studied in a model characterized by forward-lookin g investment behavior and wage contracts that provide an element of s hort-term nominal wage rigidity. The analysis shows that, in the case where the real wage is restored through a post-devaluation negotiati on, devaluation leads to a cycle in the optimal investment rate and p ossibly also in the behavior of output. The trade-balance effect is u ncertain in the short run because devaluation increases both saving a nd investment. In the long run, all real variables are unaffected by devaluation. Copyright 1988 by The editors of the Scandinavian Journal of Economics.
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