Effective protection and exchange-rate determination

Considerable research interest has entered on the implications for exchange-rate determination of fluctuations in intermediate goods prices ang changes in tariff protection. This paper draws together the strands of this literature by examining the role of effective protection in exchange rate determination. A disaggregated portfolio balance model of the open economy is used to analyze the determination of real and nominal exchange rates in the presence of rational expectations. Additionally, it is used to explore the implications for resource allocation of changes in the effective rate of protection in a country capable of influencing its terms of trade.