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Sudden stops, sectoral reallocations, and the real exchange rate

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  • Timothy J. Kehoe
  • Kim J. Ruhl

Abstract

A sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994?95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.

Suggested Citation

  • Timothy J. Kehoe & Kim J. Ruhl, 2008. "Sudden stops, sectoral reallocations, and the real exchange rate," Staff Report 414, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:414
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    Keywords

    Financial crises;

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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