Real exchange rates,asset prices and terms of trade: A theoretical analysis

This paper develops a continuous-time two-country dynamic equilibrium model, in which the real exchange rates, asset prices, and terms of trade are jointly determined in the presence of nontradable goods. The model determines the relation between the financial markets and real goods markets in the world economy and their responses to various shocks under the home bias assumption. A positive domestic supply shock induces a positive return on the domestic asset markets and a deterioration of terms of trade that improves the foreign output and boosts the foreign asset markets. Demand shocks act in the opposite way. This model also analyses the impact of change in the relative price of nontradable to tradable goods on the terms of trade and asset markets. A higher productivity growth in tradable goods than in nontradable goods leads to a higher relative price of nontradable to tradable goods, which appreciates the real exchange rate, deteriorates the terms of trade, and depresses the domestic and foreign asset markets. A lower relative price of nontradable goods depreciates the real exchange rate, improves the terms of trade, and lifts both the domestic and foreign asset markets.     

International business cycles and the relative price of investment goods

Abstract Is the relative price of investment goods a good proxy for investment specific technology? We model this relative price in a flexible price international economy with two fundamental shocks, namely, the total factor productivity (TFP) shock and the investment‐specific technology (IST) shock. We show that the one‐to‐one correspondence between the IST shock and the relative price of investment goods breaks down in an international economy because of the short‐run correlation between the terms of trade and the relative price of investment goods. The data congruent negative correlation between the investment rate and the relative price of investment goods thus does not necessarily reflect decline in investment frictions (rise in IST), as suggested by many studies. A calibration experiment with the US data demonstrates that such an inverse relation between rate of investment and the relative price of investment goods basically reflects the positive effect of TFP on the terms of trade for a broad range of economies where the home bias in consumption exceeds investment and there is a sizable adjustment cost of investment.     

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.     

Modelling structural change in the UK housing market: A comparison of alternative house price models

This paper develops a new approach to the modelling of house prices in the UK, with housing demand being conditioned directly on consumers' expenditure rather than the determinants of expenditure. Conditioning on consumption ensures that the permanent income measure used in determining the level of consumption is consistently reflected in housing demand. The effects of financial liberalisation on the relative consumption of housing and non-housing goods and services are captured using the average loan-value ratio for first-time buyers. We also allow for financial effects via the real user cost of home ownership. House prices are assumed to adjust so as to clear the housing market. The proposed model is found to have structurally stable parameters across the housing market downturn since 1990. Statistical comparisons with the more conventional models in use at HM Treasury and the Bank of England during the early 1990s provide additional evidence in favour of our proposed approach.     

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.     

The trade balance and the terms of trade in a two-country two-sector OLG economy

We consider a two-country, two-sector OLG model. It is shown that the trade balance and the relative price of exports are always positively related when exports are labor intensive regardless of the elasticity of intertemporal substitution in consumption. A large response of savings to future prices becomes a sufficient condition for an inverse relation between these variables only if exports are capital intensive. In this case, a rise in the terms of trade can be followed by a trade balance decline if consumption goods are capital intensive and the income effect implied on savings is negative and large.     

Quantifying the impact of services liberalization in a developing country

We compare goods versus services liberalization in terms of welfare, outputs, and factor prices in Tunisia using a CGE model with multiple products, services and trading partners. Restraints on services trade involve both cross-border supply (tariff-equivalent price wedges) and on foreign ownership (monopoly-rent distortions and inefficiency costs). Goods-trade liberalization yields a modest gain in aggregate welfare. Reducing service barriers generate relatively large welfare gains and low adjustment costs. Services liberalization increases economic activity in all sectors and raise the real returns to both capital and labor. The results point to the potential importance of deregulating services provision for economic development.     

Tariff pass-through and the distributional effects of trade liberalization

This paper estimates the distribution of welfare gains due to the trade reforms in India by simultaneously considering the effect on prices of tradable goods and wages. The cost of consumption for each household is affected by the domestic price changes, while wage incomes adjust to these price changes in equilibrium. Three rounds of the Indian Employment and Consumption Surveys are used for the analysis. The price transmission mechanisms are estimated for both rural and urban areas to understand the extent to which the trade reforms are able to affect the domestic prices. In order to assess the distributional effects, a series of nonparametric local linear regressions are estimated. The findings show that households at all per capita expenditure levels had experienced gains as a result of the trade liberalization, while the average effect was generally pro-poor and varied significantly across the per capita expenditure spectrum.     

Trade Liberalization and Welfare Inequality: A Demand‐Based Approach*

There is strong evidence suggesting that different income groups consume different bundles of goods. Hence, trade liberalization can affect welfare inequality via changes in the relative prices of goods consumed by different income groups (the price effect). In this paper, I develop a framework that enables us to explore the role of the price effect in determining welfare inequality. I find that trade liberalization does benefit some income classes more than others. In particular, I show that the relative welfare of the rich with respect to that of the poor has a hump shape as a function of trade costs.     

Equity home bias,incomplete financial markets,and nominal rigidities

Abstract This paper analyzes optimal portfolio decisions in a monetary open‐economy framework. It is found that market completeness and the specific form of nominal rigidities, namely, nominal price vs. nominal wage rigidities, matter for justifying the observed structure of equity holdings. When markets are complete, sticky prices generate a negative correlation between the non‐diversifiable labour income and the profit of domestic firms with respect to the productivity shocks, which explains why households invest little abroad. In contrast, when markets are incomplete, rigidities in goods prices result in a counterfactual ‘super home bias’, because domestic equities provide a good hedge against not only the labour income risk but also the relative price risk. Wage rigidities, however, have the opposite effect. Therefore, nominal rigidities in both goods prices and wage rates are needed to address the empirical composition of gross equity positions under incomplete markets.     

Skilled-unskilled wage inequality and unemployment: A general equilibrium analysis

The paper develops a static three sector competitive general equilibrium model of a small open economy in which skilled labor is mobile between a traded good sector and the non-traded good sector and unskilled labor is specific to another traded good sector. Capital is perfectly mobile among all these three sectors. We introduce involuntary unemployment equilibrium in both the labor markets and explain unemployment using efficiency wage hypothesis. We examine the effects of change in different factor endowments and prices of traded goods on the unemployment rates and on the skilled-unskilled relative wage. Also, we introduce Gini-Coefficient of wage income distribution as a measure of wage income inequality; and show that a comparative static effect may force the skilled-unskilled relative wage and the Gini-Coefficient of wage income distribution to move in opposite directions in the presence of unemployment.     

Non-Traded Goods and Real Exchange Rate Fluctuations: A Structural VAR Analysis

Real exchange rate variance decompositions indicate that only a small fraction of real exchange rate movements can be attributed to changes in the relative price between traded and non-traded goods. This paper argues that those exercises, by ignoring the nature of the shocks behind real exchange rate changes, may be inadequate to measure the relative importance of non-traded goods prices. Instead, it proposes using a structural vector autoregression (SVAR) model to study the effects of shocks to the relative supply and relative demand for non-traded goods on the real exchange rate. The SVAR model is identified via long-run restrictions and is estimated for a group of advanced economies. The results indicate that for some countries, relative supply shocks can be a significant source of real exchange rate fluctuations.     

Output and price effects of enhancing services sector competition in a large open economy

This paper studies the output and price effects of exogenous changes in the degree of competition. It is motivated by initiatives to enhance competition in services in the European Union. The paper shows that a higher degree of competition in the nontradable goods sector may have adverse implications for international price competitiveness. It highlights four channels through which enhanced competition in the non-tradable goods sector affects output and the general price level in a large, open economy (lower monopoly rents, higher wages, lower import prices, international wealth transfer) and assesses their relative importance. The conclusions suggest that the Single Market enhances output and reduces the general price level.     

Persistence of prices in the Eurozone capital cities: Evidence from the Economist Intelligence Unit City Data

Using the Economist Intelligence Unit City Data, this paper studies price differences in the Eurozone by comparing the prices of individual goods between twelve Eurozone countries. To estimate the persistence of prices, I employ a cross-sectionally augmented panel unit root test that accounts for contemporaneous as well as serial correlation. Based on the test, the estimated half-lives are 13 months for traded goods and 16 months for non-traded goods. Price differences for certain traded goods such as food or cars revert to parity much faster than prices for alcohol. To further refine the persistence estimates, I use the sequential panel selection method to determine the stationarity of individual cross-sections for each good that rejects the unit root. The distribution of stationary cross-sections between the Eurozone countries appears fairly balanced. The half-lives based only on stationary-cross-sections are reduced to 6 months for traded goods and 7 months for non-traded goods.     

Monopoly,intermediate goods and the pure theory of international trade

Conclusion In a model with two traded good sectors between which intersectoral flows of intermediate goods are allowed and with a monopolized non-traded good sector, the wage rate in terms of two traded goods increases and the rental of capital in terms of two traded goods decreases when the price of relatively more labor intensive traded good sector increases, though nothing definite can be said about the direction of change in the wage rate and rental in terms of the non-traded good. When prices of traded goods are kept constant and labor and/or capital increase(s), output of the non-traded good sector increases provided that the non-traded good is not inferior, having income elasticity of demand less than unity. The factor intensity condition for the traded goods is in general not sufficient for the validity of the Rybczynski theorem to hold with respect to net outputs of the traded goods. We have derived sufficient conditions for the magnification effect to be observed with respect to net outputs of the traded good sectors. Specifically, we have shown that the factor intensity condition (23) is sufficient for the magnification effect to prevail when only labor increases.     

The effect of firm-level productivity on exchange rate pass-through

A heterogeneous-firm trade model can explain the recent decrease in exchange rate pass-through to aggregate US import prices as a result of decreased trade costs. This paper finds support for this explanation by testing another implication of this type of heterogeneous firm model: lower exchange rate pass-through for goods that are traded for short periods of time.     

Real Exchange Rate Trends and Growth: A Model of East Asia

In contrast to the Balassa–Samuelson hypothesis, many fast-growing Asian countries have experienced little trend real exchange rate appreciation, or even depreciation. Moreover, their long-run real exchange rate trend seems to be dominated by movements in traded goods prices. A model is developed which is consistent with these observations. As in the Balassa–Samuelson model, productivity growth is concentrated in the traded goods sector. Nevertheless the real exchange rate may exhibit trend depreciation, driven by persistent deviations in the price of traded goods from those in the reference country. The key feature of the model is the presence of endogenous productivity growth in the distribution services sector.     

Productivity and consumption home bias with goods market frictions

This paper analyzes the effect of productivity gains on the consumption home bias when goods market frictions are present in the form of time costs. We find that productivity gains may either improve or worsen the home bias, depending on the relative magnitude of the terms of trade, the domestic friction, and the international friction. Our results broaden the interpretation of home bias by providing unique theoretical insight into the role of the interaction between productivity innovations and goods market frictions.     

Movements of relative agricultural prices in sub-Saharan Africa

Movements of relative agricultural prices in 20 countries insub-Saharan Africa between 1973 and 1999-95 are investigated.Changes in the net barter terms of trade of the agriculturalsector are compared with international terms of trade movements.Movements in prices received by cocoa, coffee, cotton and teafarmers are compared with unit export prices and with indicatorsof production costs. World price movements for the same commoditiesare compared with unit export prices of major exporting countries.A similar analysis is undertaken for cereals, where producerprices are compared with unit import prices and with cost indicators.Possible factors which affect these relative price movementsare discussed with special emphasis on the role of alternativepolicy regimes. Empirical findings suggest that conventionalviews on the anti-farmer bias of African policies till the 1980sare questionable and the recent liberalisation of agriculturalmarkets in Africa have not generated farmer-friendly outcomes.     

Trade liberalisation and exchange rate pass-through: the case of textiles and wearing apparels

Studies on the relationship between exchange rates and traded goods prices typically find evidence of incomplete pass-through, usually explained by pricing-to-market behaviour. Although economic theory predicts that incomplete pass-through may also be linked to the presence of non-tariff barriers to trade, variables reflecting such a link is rarely included in empirical models. In this paper, we estimate a pricing-to-market model for Norwegian import prices on textiles and wearing apparels, controlling for non-tariff barriers to trade and shift in imports from high- to low-cost countries. We apply the cointegrated VAR approach and develop measures of foreign prices based on superlative price indices (including the Törnqvist and Fischer price indices) and a data calibration method necessary to approximate relative price levels across countries. Our measures of foreign prices thereby account for inflationary differences and varying import shares and price level differences (known as the China effect) among trading partners. We show that these measures of foreign prices, unlike standard measures used in the pricing-to-market literature, are likely to produce unbiased estimates of pass-through. Once the China effect is controlled for, we find little evidence that pass-through has changed alongside trade liberalisation.