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Productivities, Trade, and Relative Prices in a Ricardian World

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  • Vahagn Galstyan

    ()
    (Institute for International Integration Studies, Trinity College Dublin)

Abstract

In an extended Ricardian model of trade, we study the effects of improving trade deficits on relative prices, and the relation between growth rates and real exchange rates. An improvement in the trade balance induces relative wages to overshoot their long-run value, placing downward pressure on the terms of trade of the same order of magnitude found in Armington type models. Once the pattern of specialization changes, some of the decline is reversed with a smaller value of long-run depreciation. We find that divergent growth rates do not cause distinct trends in the terms of trade. The result depends on the size of the non-tradable sector and the variability of industry-specific efficiencies. We also find that self-selection into export markets causes the relative price of non-traded goods to respond to demand re-balancing, giving birth to an endogenous Balassa-Samuelson effect. The model also suggests that in the long-run the stochastic variation of the real exchange rate is dominated by the volatility of the terms of trade.

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Bibliographic Info

Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp359.

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Length: 28 pages
Date of creation: 28 Feb 2011
Date of revision:
Handle: RePEc:iis:dispap:iiisdp359

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Keywords: Trade re-balancing; Relative prices; Ricardian trade; Growth;

References

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  1. Fabio Ghironi & Marc J. Melitz, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," The Quarterly Journal of Economics, MIT Press, vol. 120(3), pages 865-915, August.
  2. Corsetti, Giancarlo & Martin, Philippe & Pesenti, Paolo, 2013. "Varieties and the transfer problem," Journal of International Economics, Elsevier, vol. 89(1), pages 1-12.
  3. Vahagn Galstyan, 2007. "Country Size and the Transfer Effect," The Institute for International Integration Studies Discussion Paper Series iiisdp204, IIIS.
  4. Bergin, Paul R., 2006. "How well can the New Open Economy Macroeconomics explain the exchange rate and current account?," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 675-701, August.
  5. Christian Broda & David E. Weinstein, 2004. "Globalization and the Gains from Variety," NBER Working Papers 10314, National Bureau of Economic Research, Inc.
  6. Daron Acemoglu & Jaume Ventura, 2002. "The World Income Distribution," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 659-694, May.
  7. Tamim Bayoumi & Jaewoo Lee & Sarma Jayanthi, 2006. "New Rates from New Weights," IMF Staff Papers, Palgrave Macmillan, vol. 53(2), pages 4.
  8. Carlin, Wendy & Soskice, David, 2005. "Macroeconomics: Imperfections, Institutions, and Policies," OUP Catalogue, Oxford University Press, number 9780198776222, September.
  9. Vahagn Galstyan & Philip R. Lane, 2008. "External Imbalances and the Extensive Margin of Trade," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(3), pages 241-257, November.
  10. Gianluca Benigno & Christoph Thoenissen, 2003. "Equilibrium Exchange Rates and Supply-Side Performance," Economic Journal, Royal Economic Society, vol. 113(486), pages C103-C124, March.
  11. Galstyan, Vahagn A. & Lane, Philip R., 2008. "The Composition of Government Spending and the Real Exchange Rate," CEPR Discussion Papers 6903, C.E.P.R. Discussion Papers.
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Cited by:
  1. Vahagn Galstyan, 2011. "Terms of Trade in the Medium-run," The Institute for International Integration Studies Discussion Paper Series iiisdp382, IIIS.

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