Real Exchange Rate and Consumption Fluctuations following Trade Liberalization

Kristian Jönsson ()
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Kristian Jönsson: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

No 187, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: Two-sector models with traded and non-traded goods have problems accounting for the stylized fact that the real exchange rate appreciates and consumption booms for several years following trade liberalization, or exchange-rate-based stabilization programs, in small open economies. The paper studies three potential solutions to this ‘price-consumption puzzle’ and evaluates their quantitative importance in calibrated simulations of Spain’s accession to the European Community in 1986. Extending the standard two-sector framework, the paper investigates the effects of relative productivity growth in the traded sector along the lines of Balassa-Samuelson, of time-to-build, and of habit formation in preferences. In contrast to previous studies, we find that habit formation on its own does not enable the model to account for the observed real exchange rate and consumption dynamics. The analysis shows that a calibrated version of the model augmented with all three mechanisms can account for much of the price-consumption dynamics after trade liberalization, without losing explanatory power for other real variables in the Spanish economy after 1986.

Keywords: Non-traded goods; Balassa-Samuelsson; Time-to-build; Habit formation; Dynamic general equilibrium (search for similar items in EconPapers)
JEL-codes: C68 F41 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2005-07-01
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-int
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:hhs:rbnkwp:0187

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