Real Exchange Rate and Consumption Fluctuations following Trade Liberalization

Kristian Jönsson ()
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Kristian Jönsson: SVERIGES RIKSBANK, Research Department, Postal: SE 103 37 Stockholm, Tel +46 8 787 04 95, Fax +46 8 21 05 31,

No 568, SSE/EFI Working Paper Series in Economics and Finance from Stockholm School of Economics

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: Two-sector models; Balassa-Samuelson; Time-to-build; Habit formation; Real exchange rate; Trade liberalization (search for similar items in EconPapers)
JEL-codes: C68 F41 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2004-11-08, Revised 2005-01-04
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:hhs:hastef:0568

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