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Productivities, Trade, and Relative Prices in a Ricardian World

  • Vahagn Galstyan

    ()

    (Institute for International Integration Studies, Trinity College Dublin)

In an extended Ricardian model of trade, we study the effects of improving trade deficits on relative prices, and the relation between growth rates and real exchange rates. An improvement in the trade balance induces relative wages to overshoot their long-run value, placing downward pressure on the terms of trade of the same order of magnitude found in Armington type models. Once the pattern of specialization changes, some of the decline is reversed with a smaller value of long-run depreciation. We find that divergent growth rates do not cause distinct trends in the terms of trade. The result depends on the size of the non-tradable sector and the variability of industry-specific efficiencies. We also find that self-selection into export markets causes the relative price of non-traded goods to respond to demand re-balancing, giving birth to an endogenous Balassa-Samuelson effect. The model also suggests that in the long-run the stochastic variation of the real exchange rate is dominated by the volatility of the terms of trade.

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Paper provided by IIIS in its series The Institute for International Integration Studies Discussion Paper Series with number iiisdp359.

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Length: 28 pages
Date of creation: 28 Feb 2011
Date of revision:
Handle: RePEc:iis:dispap:iiisdp359
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  1. Ghironi, Fabio & Melitz, Marc, 2005. "International Trade and Macroeconomic Dynamics with Heterogeneous Firms," Scholarly Articles 3228377, Harvard University Department of Economics.
  2. Christian Broda & David Weinstein, 2004. "Globalization and the gains from variety," Staff Reports 180, Federal Reserve Bank of New York.
  3. Gianluca Benigno & Christoph Thoenissen, 2002. "Equilibrium exchange rates and supply-side performance," Bank of England working papers 156, Bank of England.
  4. Vahagn Galstyan and Philip R. Lane, 2008. "The Composition of Government Spending and the Real Exchange Rate," The Institute for International Integration Studies Discussion Paper Series iiisdp257, IIIS.
  5. Corsetti, Giancarlo & Martin, Philippe & Pesenti, Paolo, 2013. "Varieties and the transfer problem," Journal of International Economics, Elsevier, vol. 89(1), pages 1-12.
  6. Bergin, Paul R., 2006. "How well can the New Open Economy Macroeconomics explain the exchange rate and current account?," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 675-701, August.
  7. International Monetary Fund, 2005. "New Rates From New Weights," IMF Working Papers 05/99, International Monetary Fund.
  8. Carlin, Wendy & Soskice, David, 2005. "Macroeconomics: Imperfections, Institutions, and Policies," OUP Catalogue, Oxford University Press, number 9780198776222, March.
  9. Vahagn Galstyan & Philip R. Lane, 2008. "External Imbalances and the Extensive Margin of Trade," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 37(3), pages 241-257, November.
  10. Acemoglu, Daron & Ventura, Jaume, 2001. "The World Income Distribution," CEPR Discussion Papers 2973, C.E.P.R. Discussion Papers.
  11. Vahagn Galstyan, 2007. "Country Size and the Transfer Effect," The Institute for International Integration Studies Discussion Paper Series iiisdp204, IIIS.
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