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Net Foreign Assets, Productivity and Real Exchange Rates in Constrained Economies

  • Dimitris K. Christopoulos

    ()

    (Panteion University)

  • Karine Gente

    ()

    (University of Aix-Marseilles)

  • Miguel A. Leon-Ledesma

    ()

    (University of Kent)

Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an exogenous 2-sector growth model in which RER determination depends on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high domestic savings, the country converges to the world per capita income and RER only depends on productivity spread between sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, RER depends on both net foreign assets (transfer effect) and productivity. We then analyze the empirical implications of the model and find that, in accordance with the theory, RER is mainly driven by productivity and net foreign assets in constrained countries and exclusively by productivity in unconstrained countries.

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Paper provided by School of Economics, The University of New South Wales in its series Discussion Papers with number 2008-17.

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Length: 34 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:swe:wpaper:2008-17
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