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Convergence, capital accumulation and the nominal exchange rate

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  • Benczur, Peter
  • Konya, Istvan

Abstract

This paper develops a flexible price, two-sector growth model with a nominal side to study the role of the exchange rate in transition dynamics. We adopt a standard small open economy model with traded and nontraded goods, where the engines of growth are exogenous productivity improvements and capital accumulation. We enhance this standard framework by adding a preference for real money holdings, captured by money-in-the-utility. We follow Schmitt-Grohé and Uribe (2003) and assume that the interest rate on bonds issued by the small open economy is debt-dependent, and interpret it as a simple financial friction. We show analytically that the choice of the exchange rate regime influences the transition dynamics of a small open economy through the balance sheet of the central bank. We then calibrate the model to explore the quantitative significance of our results. We find that the choice of the exchange rate regime has significant and lasting effects on prices, consumption, investment and sectoral allocations, and the composition of financial assets.

Suggested Citation

  • Benczur, Peter & Konya, Istvan, 2013. "Convergence, capital accumulation and the nominal exchange rate," Journal of International Money and Finance, Elsevier, vol. 37(C), pages 260-281.
  • Handle: RePEc:eee:jimfin:v:37:y:2013:i:c:p:260-281
    DOI: 10.1016/j.jimonfin.2013.06.009
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    More about this item

    Keywords

    Two-sector growth model; Small open economy; Capital accumulation; Central bank balance sheet; Exchange rate regime;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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