Real Effects of Nominal shocks: a 2-sector Dynamic Model with Slow Capital Adjustment and Money-in-the-utility
This paper develops a two-sector model to study the e.ect and incidence of nominal shocks (fiscal or exchange rate policies) on sectors and factors of production. I adopt a classical twosector model of a small open economy and enrich its structure with gradual investment and a preference for real money holdings. An expansive nominal shock (fiscal expansion or a nominal appreciation) leads to increased spending (due to the role of money), which pushes nontraded prices up (with gradual capital adjustment, the short-term transformation curve is nonlinear). This translates into changes in factor rewards, capital labor ratios and sector-level employment of capital and labor. Higher nontraded prices lead to extra domestic income, validating some of the initial excess spending. This propagation mechanism leads to a persistent real e.ect (on relative prices, factor rewards, capital accumulation) of nominal shocks, which disappears gradually through money outflow (trade deficit). I also draw parallels with the NATREX approach of equilibrium real exchange rates and the literature on exchange rate based stabilizations.
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- Dornbusch, Rudiger & Mussa, Michael, 1975. "Consumption, Real Balances and the Hoarding Function," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 16(2), pages 415-21, June.
- Gábor Pula, 2003. "Capital Stock Estimation in Hungary: A Brief Description of Methodolgy and Results," MNB Working Papers 2003/7, Magyar Nemzeti Bank (the central bank of Hungary).
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