Real Adjustment and Exchange Rate Dynamics.pdf

Section 94 presents the conclusions and draws some

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nominal exchange rate to monetary and real shocks is then examined. Section 9.4 presents the conclusions and draws some comparisons between Marshallian and macroeconomic sources of exchange rate dynamics. 9.1 A Model of Sectoral Shifts and Resource Allocation In this section we introduce the basic consumption and production relationships which constitute the real part of our model, and then examine the model's properties in terms of short- and long-run equilib- rium and dynamic adjustment. The particular specification we have chosen is designed to permit, in as simple a manner as possible, an analysis of the two features mentioned in the introduction. The model is multisectoral to allow both for sectoral shocks and for reallocation of resources in response to other disturbances. A key feature of the model is that prices adjust instantaneously to clear markets, yet we distinguish between situations of short-run equilibrium, contingent on predetermined values of some variables, and long-run or full equilibrium. The distinction arises due to the multisectoral framework combined with the assumption that factor reallocation, in particular changes in sectoral capital stocks, is costly and hence takes time. There are three sectors in the model: two traded goods, benzine and manufactures; and one nontraded good, services. The first two are pro- duced and consumed domestically; both have perfect substitutes avail- able in infinitely elastic supply in world markets, so their foreign currency prices, and hence their relative price, can be taken as given. The price of services adjusts instantaneously to equate the domestic demand and supply for services. Since the economy is "small" in traded goods markets, demand reper- cussions of various shocks impinge only on the services sector. Hence most of our focus is on the structure of production. In one traded goods sector capital is combined with a sector-specific factor, or natural re- source, to produce benzine. In the other, capital and labor are used in combination to produce manufactured goods. In the nontraded goods sector, services are produced using only labor. 2 2. In Neary and Purvis (1982), where we also employ this real structure, we relate it to alternative models used in the analysis of the "Dutch Disease," e.g., Buiter and Purvis (1983) and Corden and Neary (1981).
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288 J. Peter Neary/Douglas D. Purvis Factors differ not only with respect to where they are used, but also with respect to how quickly they can move between uses. Labor is assumed to be mobile between the sectors in which it is used—services and manufacturing—with the wage rate adjusting to clear the labor market. Capital, however, is "bolted down" and hence sector-specific in the short run; only with time can the capital stock in the sectors in which it is used—manufacturing and benzine—adjust in response to changing factor rewards. Note that there is no direct factor market link between the benzine and services sectors, but that over time there is an indirect link operating through the manufacturing sector.
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