AN EXPLORATION OF THE
INTERDEPENDENCIES BETWEEN THE
REAL EXCHANGE RATE AND THE SIZE
OF THE TRADABLE SECTOR IN A SMALL
OPEN ECONOMY
Zarzosa Valdivia Fernando and Pentecost Eric
Arnoldshain Seminar XI, University of Antwerp 2013
CONTENT





Introduction: An Australian Model focused on the structural
real exchange rate (SRER=PT/PN) (and the economic
structure?)
Microfounded Model: Assumptions
SRER and the Tradable goods share in GDP (Tshare): Interrelationships and equilibrium relationships
Effects of exogenous shocks on the SRER and Tshare
Conclusions
INTRODUCTION: AN AUSTRALIAN MODEL
N
Salter-Swan Model:
Fundamentals: SRER-Ec.
Structure
•TFPX, TFPM, TFPN
• K-L
•TT
•DS (debtss-transfers)
NA
A
IA
PPF
0
TA
SRERA
=
PT/PN
T
MICROFOUNDED MODEL: ASSUMPTIONS







Rational economic agents, CES Pref, Cobb-Douglas T, Linear N
Three goods: two tradable goods (Primary and Manufacturing)
and one non-tradable goods
Two factors with a constant endowment: labour and capital
Perfect factor mobility between sectors
Exogenous debt service (interest payments) and transfers to
GDP,
Exogenous terms of trade
Perfectly competitive goods and factor markets
SRER AND TSHARES
SRER
Larger Tshare, creates an excess supply of
T excess demand for N, SRER must
diminish to switch expenditure from N-T
and restore eq CA, Nmkt
SRER0
E0

SRER    d (Tshare)   d ( DS ) 
T , DS
T , DS
C
Tshare
0
Tshare0
Tshare
SRER AND TSHARES




d (Tshare)  X TFP X  M TFP M   X  M  ( SRER  TFP N )



 L Lˆ  K Kˆ  (1  TT ) X  TTM TT
SRER
Tshare
SRER0
E0
0
Tshare0
P
Tshare 
PX X  PM M PX X  PM M

GDP
wL  rK
Tshare
SRER AND TSHARES




d (Tshare)  X TFP X  M TFP M   X  M  ( SRER  TFP N )
SRER



 L Lˆ  K Kˆ  (1  TT ) X  TTM TT
Tshare
SRER0
P
E0

SRER    d (Tshare)   d ( DS ) 
T , DS
T , DS
C
Tshare
0
Tshare0
Tshare
SRER AND TSHARES



SRER



 L Lˆ  K Kˆ  (1  TT ) X  TTM TT
Tshare
SRER0
P
E0

SRER    d (Tshare)   d ( DS ) 
T , DS
T , DS
C
Tshare
0
Development
Models

d (Tshare)  X TFP X  M TFP M   X  M  ( SRER  TFP N )
Tshare0
Neary and Purvis (82)
Rodrik (2008) and
van der Ploeg (2010,2011)
Tshare
Sector
Productivity
Transfers
SRER AND THE TSHARE RESPONSES TO SHOCKS
Exogenous shocks
Variables
Sector TFP shocks
Primary
ManuNonfacturing tradables
TFPX
TFPM
TFPN
Linkages
Factor
endowments
L
K
Terms of
trade
Debt service
minus
transfers
TT
DS
SRER
Tshare
SRER
Tshare
Xshare
+
+
+
+
+
+
-
+
-
+
-
?+
??+
+
+
+
-
-
?
?
+
+
Mshare
-
+
-
?
?
-
+
SRER Tshare
+
+
The first two rows correspond to the relationships of the TshareC and TshareP lines, respectively
The third and fourth row are the equilibrium relationships
The last two rows shows the response of the equilibrium share in GDP of the primary and manufacturing sectors to
exogenous shocks
A “+” indicates a positive effect, a “-” a negative one and a “?” an ambiguous effect; signs in subscripts are valid
relationships when TT improvements appreciate the SRER
Dutch Disease
SRER, TSHARE AND TFPX
θT
d0
SRER
Tshare
SRER0
E0
Tshare
0
Tshare d 
PX X  PM M
PX X  PM M  PN N
P
C
θT0
Tshare(=θT)


 

 

d (Tshared )  (1  T )   X TFPX   M TFPM  T TFPN    X (1   )   M  TT  T SRER 



θTd0
SRER, TSHARE AND TFPX
θT
d0
(X0)
θT
d01
(X01)
P
Tshare (TFPX0)
SRER
P
θT (TFPX1)
SRER0
E0
E02
E01
TFPX1 >TFPX0
SRER1

X 01  X 0 (1  TFPX )
E1
Tshare
0
θT0
θT01 θT1
C
θT02
Tshare(=θT)
EPE+
TE+
RME+
SE-
θTd0is derived from
Tshare d 
PX X  PM M
PX X  PM M  PN N
SRER, TSHARE AND FACTOR ENDOWMENTS (L)
θTd0
SRER
TshareP(L1)
SRER1
SRER0
TshareP(L0)
E1
E02
E0
L1 >L0
TshareC
0
θT02
θT1
θT0
RMESE+
TE-
Tshare(=θT)
SRER, TSHARE AND TERMS OF TRADE (TT)
θT
d0
P
Tshare (TT1) case (b)
(TT0)
SRER
P
Tshare (TT0)
P
Tshare (TT1) case (a)
SRER01
SRER1’
SRER0
E02’
E01’
E01
E1’
E0
TT1 >TT0
SRER1
0
E02
E1
θT1’
C
Tshare
θT02’θT0 θT01 θT01’ θT1
EPE+
θT02
PE+
RME+
TE+
RME-
SETE-
Tshare(=θT)
SECase (b)
Case (a)
SRER, TSHARE AND DEBT SERVICES-TRANSFERS (DS)
SRER
θT
d0
Tshare
SRER0
P
E02
SRER1
E0
DS1 < DS0
E1
C
Tshare (DS0)
C
Tshare (DS1)
0
θT02
θT1
θT0
EMESuE+
SE-=TE-
Tshare(=θT)
EFFECTS OF EXOGENOUS SHOCKS IN AN ECONOMY
Extraordinary
Profits effects
Price
effects
Resource
Movement
effects
Expenditure
Movement
Effect
Substitution
Effects
Spending
effects
Total
Effects
Tradable
share
SRER
TFPX
+
+
-
+
Inc.
App.
TFPM
+
+
-
+
Inc.
App.
TFPN
-
-
+
-
Dim.
Dep.
+
-
+
Inc.
App.
-
+
-
Dim.
Dep.
+
+
Inc.
Dep.
TT
DS
+
+
+
-
A plus (minus) indicates that the corresponding shock increases (decreases) the tradable share
Inc. and Dim. indicates that the tradable share increases or diminishes, respectively
App. and Dep. refer to appreciation and depreciation, respectively
CONCLUSIONS
Theoretically: SRER, Tshares are simultaneous
determined
 Role of Fundamentals: TFPs, L-K, TT, DS; ∆TT
and ▼DS may give rise to the Dutch Disease
 Measuring resource allocation as the change
in the Tshare, the EPE, PE, EME, RME, SuE, SE
of exogenous shocks are identified and
distinguished

THANK YOU
BEDANKT!
AN AUSTRALIAN MODEL: TFPT
N
NA=NB
ND
B
A
IB
D
C
NC
IA
SRERC
PPF
SRERA
PPF’
0
TA
TB
TD
TC
SRERA
T
AN AUSTRALIAN MODEL: EFFECTS
N
NA=NB
ND
B
A
IA
D
C
NC
IA
SRERC
PPF
SRERA
PPF’
0
TA
TB
EPE
TD
TC
T
RME
SE
TE
SRERA
Structural real exchange rate (SRER)
PT  SPT*
T
CT
PT SPT*
SRER 

PN
PN
CN
Universidad
Nacional de Córdoba
N
SRER and RERPPP
T
CT
PT SPT*
SRER 

PN
PN
CN
N
Domestic
Goods
Foreign
RERPPP 
SP *

P
 SRER 
f

 SRER * 
exogenous
Theoretical Microfounded Model: Main Relationships
Consumers No consumers Consumers: CES Determinants
Assumption
decisions
Preferences
Producers
assumptions
No producers
decisions
T and N goods are endowed
Goods endowment
variations equal to sector
TFPs changes
Linear technology in the N
sector
P
r
o
d
u
c
e
r
s
SRER model only
Linear
SRER model only
(assuming
constant Tradable
shares)
Goods
endowments,
TT, CAMRDF
Sector TFPs, TT,
CAMRDF
Sector TFPs,
factor
endowments,
TT, CAMRDF
SRER-Tradable
share
interdependences
Sector TFPs,
factor
endowments,
TT, CAMRDF
SRER model only
(‘variable tradable
share’)
Flexible RFPs
SRER-RFPs
interdependences
plus SRERTradable shares
interdependences
Sector TFPs,
factor
endowments,
TT, CAMRDF
SRER-RFPs
interdependences
RFPs Rigidities
SRER-u
interdependences
plus SRERTradable shares
interdependences
Sector TFPs,
capital
endowments,
TT, CAMRDF
SRER-u
interdependences
technolgoy in the N
sector
Cobb-Douglas
technology in
the T sectors
SRER model only
Cobb-Douglas
preferences
CES
technology in the
N sector
T= Tradable goods (sector), N= Non-tradable goods (sector), SRER= Structural real exchange rate, RFP=
Relative factor prices, u= unemployment rate, TFP= Total factor productivity, TT= terms of trade and
CAMRDF= -Debt obligations

Pˆ  Sˆ  0 
ARGENTINA TODAY:

ˆ 0
SRER

A212
L(SRER)
SRER
Tshare


RERPPP  Sˆ Pˆ  Pˆ*0
P
C
Tshare (SRER)
E0
GM
SRER(log(100-u))
SRER0
E0
GE
SRER1
Tshare
0
Tshare0
Required
Produced
Dollars required to correct the
current account
L2
L1
1
L0
log(100-u)
2
Unemployment
expected
Real Depreciation required (▼PN or devaluation) or Productivity, Inv, ▼ gov.spending that
falls in non-tradables

Pˆ  Sˆ  0 
ARGENTINA TODAY:


ˆ 0
SRER
L(SRER)
SRER
Tshare


RERPPP  Sˆ Pˆ  Pˆ*0
P
SRER(log(100-u))
C
Tshare (SRER)
E0
GM
SRER0
E0
GE
US$: reserve
Aggravate
Tshare
0
Tshare0
Required
Produced
Dollars required to correct the
current account
L2
L1
1
L0
log(100-u)
2
Unemployment
expected
Real Depreciation required (▼PN or devaluation) or Productivity, Inv, ▼ gov.spending that
falls in non-tradables