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

  • Dimitris K. Christopoulos
  • Karine Gente
  • Miguel A. Leon-Ledesma

    ()

Empirical evidence suggests that real exchange rates (RER) behave differently in developed and developing countries. We develop an overlapping generations two-sector exogenous growth model in which RER determination may depend on the country's capacity to borrow from international capital markets. The country faces a constraint on capital inflows. With high demestic savings, the RER only depends on productivity spread between two sectors (Balassa-Samuelson effect). If the constraint is too tight and/or domestic savings too low, the 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, the RER is mainly driven by productivity and net foreign assets in constrained countries and by productivity in unconstrained countries.

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Paper provided by School of Economics, University of Kent in its series Studies in Economics with number 1011.

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Date of creation: Dec 2010
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Handle: RePEc:ukc:ukcedp:1011
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School of Economics, University of Kent, Canterbury, Kent, CT2 7NP

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