Monetary Shocks and Real Exchange Rate Dynamics: a Reappraisal

This paper proposes a two‐country general‐equilibrium model incorporating a tradable sector with pricing‐to‐market as well as a nontradable sector. In that case, real exchange rate fluctuations arise from two sources: changes in the relative price of traded goods, that exemplify deviations from the law of one price, and movements in the relative price of traded to nontraded goods across countries. Our framework sheds light on the propagation mechanisms through which monetary shocks affect the real exchange rate. More specifically, the two components respond in opposite directions to monetary disturbances, which is consistent with data. Besides, the introduction of nontraded goods does not alter the predictive power of monetary shocks because the presence of nontraded goods magnifies the response of the deviation from the law of one price.     

UNDERSTANDING REAL EXCHANGE RATE MOVEMENTS WITH TRADE IN INTERMEDIATE PRODUCTS

We suggest that it may be ‘too easy’ to attribute real exchange rate movements to deviations from the law of one price. We show that it is immaterial whether one uses seemingly traded goods, nontraded goods, or even a single, unimportant consumer good, say beer. The ease of attributing the variation to any such deviations is explained using a model with intermediate goods trade. In the model, the stage of production determines the traded/nontraded distinction. We find empirical substantiation for the model: law of one price deviations lose explanatory power and, defined appropriately in terms of intermediate goods, relative prices matter.     

Real exchange rate fluctuations,wage stickiness and tradability

When we classify factors of production by their tradability, the relative wage of nontraded labour influences the real exchange rate through the relative cost of distribution services. We confirm this prediction using monthly data on the sector‐level US–Canada real exchange rate and the relative wage of service‐producing labour. The relative wage accounts for 40% of the variability of the real exchange rate at a one‐month horizon. Furthermore, when we use the effective nontraded labour content to classify goods into nontraded and traded ones, the variability of the price of the nontraded‐goods basket accounts for more than half of the variability of the real exchange rate.     

Nontraded Goods and Real Exchange Rates in a Multi‐Good Ricardian Model

The two‐country Ricardian trade model with discrete goods and uniform transport costs for tradable goods is applied to the decomposition of the real exchange rate into traded and nontraded components. The real exchange rate is driven almost entirely by changes in the productivity differentials in nontraded goods and also explains the Balassa–Samuelson effect of a lower cost of living in poor countries, but extraordinary transport costs for some nontraded goods are necessary to easily explain the Balassa–Samuelson effect.     

The Behaviour of Real Exchange Rates: The Case of Japan

This study examines the convergence rate of mean reversion by estimating the half‐lives of sectoral real exchange rates using an extensive product price panel for Japan (with the USA as the numéraire). We find that the half‐lives of sectoral real exchange rates are remarkably distorted when the grouped half‐life is measured inappropriately and the cross‐sectional dependence and potential trend breaks are ignored. After taking account of these problems, the bias‐corrected half‐life for all goods is as low as 3.00 years, close to the bottom of the consensus view of 3 to 5 years. Moreover, the bias‐corrected half‐life of mean reversion is 2.40 years for traded goods, and only approximately half that for non‐traded goods. Finally, our findings also support the view that small‐sample bias correction is critical for half‐life estimations.     

Sectoral Capital–Labor Ratios and Total Factor Productivity: Evidence from Asia

This paper examines the relationship between sectoral capital–labor ratios and total factor productivity (TFP) for six Asian economies in the context of the Balassa–Samuelson model. A strong prediction of the model is that the capital–labor ratios in both the traded‐ and nontraded‐goods sectors depend on the TFP in the traded‐goods sector. Both single‐equation and panel cointegration tests support this implication of the model.     

TOURISM,DUTCH DISEASE AND WELFARE IN AN OPEN DYNAMIC ECONOMY*

This paper examines the effects of an expansion in tourism on capital accumulation, sectoral output and resident welfare in an open economy with an externality in the traded good sector. An expansion of tourism increases the relative price of the nontraded good, improves the tertiary terms of trade and hence yields a gain in revenue. However, this increase in the relative price of nontraded goods results in a lowering of the demand for capital used in the traded sector. The subsequent de‐industrialization in the traded good sector may lower resident welfare. This result is supported by numerical simulations.     

Reconsidering Real Interest Parity for Traded and Nontraded Goods

The goal of this paper is to examine the hypothesis of real interest rate parity by contrasting real interest rates across traded and nontraded goods under flexible exchange rates. We employ panel unit root tests to investigate the stationarity of real interest rate differentials. In particular, empirical results support the mean‐reverting property of real interest rate differentials for interest rates measured in terms of traded goods.     

A Model of Endogenous Nontradability and its Implications for the Current Account*

This paper studies how nontraded goods limit the ability of a country to finance current account deficits. It uses an intertemporal model of the current account for a small open economy where goods are endogenously nontraded due to explicit trade costs. The economy has an endowment of two goods with differing trade costs, either of which can be traded or nontraded in equilibrium. The model implies that current account deficits impose a cost, in the form of raising the effective interest rate in the country. The findings differ from some recent studies: first, in that the interest rate rises even for countries with modest current account deficits; secondly, the interest rate cost eventually reaches an upper bound as current account deficits grow, and progressively more nontraded goods become traded to service the debt. Panel regression analysis of interest rate and current account data is consistent with our conclusions.     

International capital and nontraded goods in the long run

The present paper develops the comparative static properties of a small open economy which produces both traded goods and nontraded goods, and is a price taker in the international market for productive capital. Assumptions of full employment, competitive markets, and international mobility of productive cap ital input capture a long run horizon. Comparative static results associated with the wage, labor, and the price of the nontraded good are independent of factor intensity, factor substitution, and demand for the nontraded good. A tax on the traded good and a capital subsidy together raise national income and the real wage.     

Productivity,the Terms of Trade,and the Real Exchange Rate: Balassa–Samuelson Hypothesis Revisited

The paper examines how the Balassa–Samuelson hypothesis is affected by a modern variation of the standard model that allows product differentiation (within the traded and nontraded goods sectors) with the number of firms determined exogenously or endogenously. The hypothesis is found to be fragile in the modified framework. Small variations in the elasticity of substitution between home and foreign traded goods (within the range of estimates suggested in the literature), for example, can make the effect of a traded‐goods productivity improvement on the real exchange rate negative or positive, as well as small or large. This result provides a potential explanation of the mixed empirical results that have been obtained on the relationship between productivity and the real exchange rate.     

Nontraded Goods and the Current Account

This paper investigates trade balance and current account behavior in response to various shocks when the economy produces and consumes both traded and nontraded goods. Previous analyses of these problems have interpreted current account behavior in terms of tension between parameters that measure intratemporal and intertemporal elasticity, respectively. This paper provides a simple general criterion for whether trade and current account behavior is "perverse" vis-à-vis the standard one-good model results: behavior is perverse if and only if traded and nontraded goods are Edgeworth complements; that is, if the cross-partial of the instantaneous utility function is positive.     

INTERNATIONAL FACTOR MOBILITY,NONTRADED GOODS AND TARIFF REFORM*

Within models of traded and nontraded goods, that ignore international factor mobility, the literature on tariff reform has established sufficient conditions under which a policy that reduces (increases) the highest (lowest) tariff to the level of the second highest (lowest) rate, or a policy that moves proportionally all tariffs to a given number improves welfare. The present paper generalizes previous studies by introducing perfect international capital mobility. It demonstrates that if all goods are normal in consumption and the nontraded good markets are locally Walras stable, then a reform policy that reduces (increases) the highest (lowest) tariff to the level of the next highest (lowest) rate improves welfare if (i) the good with the highest (lowest) tariff rate is a net substitute to all other traded goods, and (ii) the nontraded goods are net substitutes to all other goods. Second, a policy reform that moves all tariffs to a given number is always welfare improving.     

Risk Aversion and International Markets: Does Asset Trade Smooth Real Income?*

In a two-country model, complete asset markets do not guarantee that individuals will choose to eliminate all (diverifiable) risk in aggregate consumption. the presence of nontraded goods forces individuals to choose between reducing uncertainty in aggregate consumption and in the composition between traded and nontraded goods. This choice depends on a comparison of the standard coefficient of relative risk aversion with a second type of risk aversion that becomes relevant when nontraded goods are present, one that captures aversion to risk in composition. Regardless of the decision made, asset trade always reduces the risk premium.     

Are there bubbles in Chinese RMB–dollar exchange rate? Evidence from generalized sup ADF tests

This article uses recently developed generalized sup ADF (GSADF) unit root tests into the analysis of nominal RMB–dollar exchange rates bubbles. Based on the results from the GSADF tests, we find strong evidence of explosive behaviour in the nominal exchange rate and investigate two bubbles there. The first bubble is during 2005–2006 which is determined neither by the relative prices of traded goods nor the relative price of nontraded goods. The second bubble busts in 2008 during subprime crisis period, and which is determined by the relative prices of traded goods but not the relative price of nontraded goods. There is no bubble before 2005 as the exchange rate is under fixed regime. As for this result, some expansionary monetary and fiscal policies are required in China since these are the most efficient and effective under a bubble burst scenario.     

On the Terms of Trade and Sectoral Reallocations

A commonly held view is that a small open economy adjusts to a negative external shock by switching both expenditure and resources toward the domestic traded goods sector. We show that, when both labor and imported inputs are used as factors of production, the average labor intensity in the nontraded sector may increase substantially with a decline in the terms of trade. This can lead to an internal transfer of labor into the nontraded sector, and an improvement in the trade balance even with a decline in traded sector output. This result depends on a combination of a high elasticity of substitution across nontraded varieties and large differences in labor intensities in the production of nontraded varieties. Our analysis suggests that intersectoral labor flows are not necessarily a good measure of an economy's flexibility, and that intersectoral resource reallocation and expenditure‐switching can move in opposite directions.     

Intranational Price Convergence and Price Stickiness: Evidence from Denmark

We show that estimates of the half‐life of deviations from the law of one price are biased when their precision is not taken into account when aggregating data for different types of goods. Using a comprehensive dataset with monthly price data for 124 homogeneous products across regions in Denmark over the period 1997–2010, we find a large positive aggregation bias. On average, we find that the half‐life is 8.4 months when taking the bias into account, compared with 28.7 months when applying the standard method. The heterogeneity in the estimated half‐life can be explained by price stickiness, distance between regions, and whether the good is traded or non‐traded.     

Traded and Nontraded Goods and Real Wages

The paper explains most, if not all, observations made by the empirical literature regarding the behavior of skilled and unskilled real wages in the United States, especially those since 1980. Generalizing the Stopler–Samuelson theorem, the authors show that the nontraded sector is critical to explaining the effects of changes in the price of traded goods on relative and absolute wages. Factor‐intensities play their role as in the traditional Stolper–Samuelson model, but the output of the nontraded sector matters as well. Specifically, freer trade benefits capital and hurts both the skilled and unskilled labor if the import as well as the nontraded sectors contract. This is a new result to the literature on Stolper–Samuelson issues.     

Tariffs in a Ricardian Model with a Monopolistically Competitive Sector: the Role of Nontradables

It is shown that for a small open economy the welfare effects of a tariff on the import of the brands of a differentiated good depends crucially on the pattern of trade. The literature has shown that welfare rises when the domestic brands are nontraded. But when the domestic brands are traded, the imposition of a tariff lowers welfare by shifting demand towards the nontraded homogeneous good which causes exit from the differentiated goods industry.