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Real exchange rate dynamics: The role of elastic labor supply

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

Abstract

Empirical evidence suggests that the flexibility of labor supply is closely related to the dynamic adjustment of the real exchange rate. This paper investigates this relationship in a two-sector dependent economy model. While, the long-run equilibrium real exchange rate is independent of the elasticity of labor supply, our analysis confirms that the nature of the labor supply can be a crucially important determinant of its short-run dynamics. The extent to which this is so depends to some degree on the source of the underlying structural change that is driving the dynamics of the real exchange rate. Numerical simulations confirm that this mechanism may help explain the larger short-run volatility and more rapid convergence typically associated with developing countries having less flexible labor markets.

Suggested Citation

  • 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.
    • Handle: RePEc:eee:jimfin:v:30:y:2011:i:7:p:1303-1322
    DOI: 10.1016/j.jimonfin.2011.06.018
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    More about this item

    Keywords

    Elastic labor supply; Real exchange rate; Persistence; Volatility;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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