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Elasticity of Substitution and the Persistence of the Deviation of the Real Exchange Rates

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  • Stephen J. Turnovsky
  • A.K.M. Mahbub Morshed

    ()
    (Economics Southern Illinois University)

Abstract

Empirical evidence suggests (i) that the real exchange rates of developing economies show less persistence than do those of more advanced economies and (ii) that the elasticity of substitution between capital and labor tends to increase from below unity for less developed economies to above one for more advanced economies. This paper shows how the introduction of sectoral adjustment costs in a two-sector model of a small open economy, together with CES production functions, provides a very natural explanation of this empirical regularity. Other aspects of the relationship between the technologies and the speed of convergence of the real exchange rate are also discussed.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 39.

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Date of creation: 11 Nov 2005
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Handle: RePEc:sce:scecf5:39

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Keywords: Real Exchange Rate; Elasticity of Substitution; Adjustment Costs;

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Cited by:
  1. Brock, Philip L., 2011. "The Penn-Balassa-Samuelson effect through the lens of the dependent economy model," Journal of Economic Dynamics and Control, Elsevier, vol. 35(9), pages 1547-1556, September.
  2. Serpil Bouza & Stephen J. Turnovsky, 2012. "The Effects of Foreign Transfers with Flexible Labor Supply," Ekonomi-tek - International Economics Journal, Turkish Economic Association, vol. 1(1), pages 1-39, January.
  3. Mahbub Morshed, A.K.M. & Turnovsky, Stephen J., 2011. "Real exchange rate dynamics: The role of elastic labor supply," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1303-1322.

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