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Devaluation, Capital Formation, and the Current Account

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  • Wen-Ya Chang

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  • Hsueh-Fang Tsai
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    Abstract

    This paper re-examines the effects of devaluation and a rise in the rate of devaluation on capital formation and the current account in an optimizing monetary model of a small open economy with endogenous labor, investment with adjustment costs, and perfect capital mobility. It is shown that devaluation leads to capital accumulation and a current-account deficit in the long run and during the adjustment process, whereas a rise in the rate of devaluation has an ambiguous impact on capital formation and the current account depending on the relationship between consumption and real balances in the utility function. If consumption and real balances are separable or complements, then a rise in the rate of devaluation produces capital decumulation and a current-account surplus in the long run as well as on the transition path. These results stand in sharp contrast with Calvo (1981). Copyright Springer Science + Business Media, LLC 2006

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    File URL: http://hdl.handle.net/10.1007/s11079-006-9053-x
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    Bibliographic Info

    Article provided by Springer in its journal Open Economies Review.

    Volume (Year): 17 (2006)
    Issue (Month): 3 (July)
    Pages: 341-357

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    Handle: RePEc:kap:openec:v:17:y:2006:i:3:p:341-357

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    Web page: http://www.springerlink.com/link.asp?id=100323

    Related research

    Keywords: devaluation; capital formation; adjustment costs; endogenous labor; perfect capital mobility; the current account;

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    1. Zou, Heng-fu, 1995. "A dynamic model of capital and arms accumulation," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 371-393.
    2. Chang, Wen-ya & Tsai, Hsueh-fang & Lai, Ching-chong, 2002. "Anticipated foreign military threat, arms accumulation, and the current account in a small open economy," Journal of International Money and Finance, Elsevier, vol. 21(7), pages 1035-1052, December.
    3. Stephen J. Turnovsky, 1997. "International Macroeconomic Dynamics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262201119, December.
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