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The exchange rate, diversification, and distribution in a modified Ricardian model with a continuum of goods

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  • Arslan Ramzi

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    (University of Massachusetts Amherst)

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    Abstract

    Several recent empirical and theoretical studies have revived interest in the relationship between the level of the exchange rate and economic development. This paper develops a dynamic model based on the Ricardian framework with a continuum of goods to consider the issue from a somewhat different perspective. In the short run, a devaluation can boost profits in spite of real wage rigidity. Moreover, the resulting diversification can offset the negative consequences for the trade balance of higher employment and profitability at home. Over the longer run, and in the presence of learning-by-accumulation, the initial boost to profits and investment induced by a devaluation could enable a country to gain a permanent foothold in new sectors at a higher real wage. While directly suppressing the real wage could also lead to diversification, what makes nominal devaluations a particularly useful tool is that these make it possible to expand domestic profits while limiting internal distributional con.ict and the ensuing negative effects on development. JEL Categories:

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    Bibliographic Info

    Paper provided by University of Massachusetts Amherst, Department of Economics in its series UMASS Amherst Economics Working Papers with number 2010-06.

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    Date of creation: Sep 2010
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    Handle: RePEc:ums:papers:2010-06

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    1. Olivier CADOT & Céline CARRERE & Vanessa STRAUSS-KHAN, 2007. "Export Diversification:What’s behind the Hump?," Working Papers 200724, CERDI.
    2. Andrew Berg & Jonathan D. Ostry & Jeromin Zettelmeyer, 2011. "What makes growth sustained?," Working Papers 133, European Bank for Reconstruction and Development, Office of the Chief Economist.
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    4. Polterovich, Victor & Popov, Vladimir, 2003. "Accumulation of Foreign Exchange Reserves and Long Term Growth," MPRA Paper 20069, University Library of Munich, Germany.
    5. Simon Johnson & Jonathan D Ostry & Arvind Subramanian, 2010. "Prospects for Sustained Growth in Africa: Benchmarking the Constraints," IMF Staff Papers, Palgrave Macmillan, vol. 57(1), pages 119-171, April.
    6. Ricardo Hausmann & Dani Rodrik, 2002. "Economic Development as Self-Discovery," NBER Working Papers 8952, National Bureau of Economic Research, Inc.
    7. Brenton, Paul & Newfarmer, Richard, 2007. "Watching more than the Discovery channel : export cycles and diversification in development," Policy Research Working Paper Series 4302, The World Bank.
    8. Arvind Subramanian & Jonathan David Ostry & Simon Johnson, 2007. "The Prospects for Sustained Growth in Africa," IMF Working Papers 07/52, International Monetary Fund.
    9. Paulo Gala, 2008. "Real exchange rate levels and economic development: theoretical analysis and econometric evidence," Cambridge Journal of Economics, Oxford University Press, vol. 32(2), pages 273-288, March.
    10. Miklós Koren & Silvana Tenreyro, 2007. "Volatility and Development," The Quarterly Journal of Economics, MIT Press, vol. 122(1), pages 243-287, 02.
    11. Xiang, Chong, 2007. "Diversification cones, trade costs and factor market linkages," Journal of International Economics, Elsevier, vol. 71(2), pages 448-466, April.
    12. Imbs, Jean & Wacziarg, Romain, 2000. "Stages of Diversification," CEPR Discussion Papers 2642, C.E.P.R. Discussion Papers.
    13. Krugman, Paul, 1987. "The narrow moving band, the Dutch disease, and the competitive consequences of Mrs. Thatcher : Notes on trade in the presence of dynamic scale economies," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 41-55, October.
    14. Klinger, Bailey & Lederman, Daniel, 2004. "Discovery and development : an empricial exploration of"new"products," Policy Research Working Paper Series 3450, The World Bank.
    15. Arslan Razmi & Martin Rapetti & Peter Skott, 2009. "The Real Exchange Rate as an Instrument of Development Policy," UMASS Amherst Economics Working Papers 2009-07, University of Massachusetts Amherst, Department of Economics.
    16. Pedro S. Martins & Yong Yang, 2007. "The Impact of Exporting on Firm Productivity: A Meta-Analysis," Working Papers 6, Queen Mary, University of London, School of Business and Management, Centre for Globalisation Research.
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