The Exchange Rate, Diversification, and Distribution in a Modified Ricardian Model with a Continuum of Goods

Arslan Razmi
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Arslan Razmi: Asian Development Bank Institute (ADBI)

Macroeconomics Working Papers from East Asian Bureau of Economic Research

Abstract: Several recent empirical and theoretical studies have revived interest in the relationship between the level of the exchange rate and economic development. This paper develops a dynamic model based on the Ricardian framework with a continuum of goods to consider the issue from a somewhat different perspective. In the short run, a devaluation can boost profits despite real wage rigidity. Moreover, the resulting diversification can offset the negative consequences for the trade balance of higher employment and profitability at home. Over the longer run, and in the presence of learning by accumulation, the initial boost to profits and investment induced by a devaluation could enable a country to gain a permanent foothold in new sectors at a higher real wage. While directly suppressing the real wage could also lead to diversification, what makes nominal devaluation a particularly useful tool is that it makes it possible to expand domestic profits while limiting internal distributional conflict and the ensuing negative effects on development.

Keywords: the exchange rate and economic development; Ricardian framework; Trade Balance; exchange rate (search for similar items in EconPapers)
JEL-codes: F12 F16 O24 O40 (search for similar items in EconPapers)
Date: 2011-12
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