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Expanding Varieties in the Nontraded Goods Sector and the Real Exchange Rate Depreciation

  • He, Qichun

This paper studies how the real exchange rate changes with economic growth. Although Devereux (1999) proves that endogenous growth in the distribution sector can cause exchange rate depreciation, MacDonald and Rucci (2005) empirically find that growth in the distribution sector significantly causes the exchange rate to appreciate. To resolve the discrepancy, we replace perfect competition with monopolistic competition in the nontraded goods sector. Although growth of the distribution sector may cause the currency to appreciate, the endogenous growth in the nontraded goods sector tends to cause the currency to depreciate, because the expanding varieties from monopolistic competition drive down the price index of nontraded goods. With reasonable structural parameters, the latter effect dominates, and the real exchange rate depreciates. An economy with a smaller elasticity of substitution between demand for different varieties of the nontraded goods or higher TFP growth in the nontraded goods sector is more likely to have real exchange rate depreciation.

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File URL: http://mpra.ub.uni-muenchen.de/31309/1/MPRA_paper_31309.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 31309.

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Date of creation: Oct 2010
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Publication status: Published in Journal of International and Global Economic Studies 2.3(2010): pp. 19-38
Handle: RePEc:pra:mprapa:31309
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  1. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, June.
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  16. Takatoshi Ito & Peter Isard & Steven Symansky, 1999. "Economic Growth and Real Exchange Rate: An Overview of the Balassa-Samuelson Hypothesis in Asia," NBER Chapters, in: Changes in Exchange Rates in Rapidly Developing Countries: Theory, Practice, and Policy Issues (NBER-EASE volume 7), pages 109-132 National Bureau of Economic Research, Inc.
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