Artículo Neary

Sectoral Shocks in a Dependent Economy: Long-Run Adjustment and Short-Run Accommodation Author(s): J. Peter Neary and Douglas D.
Purvis Source: The Scandinavian Journal of Economics, Vol. 84, No. 2, Proceedings of a Conference on Long-Run Effects of Short-Run Stabilization Policy (1982), pp. 229-253 Published by: Wiley on behalf of The Scandinavian Journal of Economics Stable URL: http://www.jstor.org/stable/3439637 . Accessed: 04/07/2013 15:21
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Scand. J. ofEconomics 84 (2), 229-253,1982
Sectoral Shocksin a Dependent Economy: LongrunAdjustment and Short-run Accommodation

J. Peter Neary
University Ireland College,Dublin,
Douglas D. Purvis*
Queen'sUniversity, Canada Kingston, Ontario,
Abstract
Thispaperexamines theallocation and stabilization of a resource boomin a consequences smallopeneconomy. Boththeintersectoral allocation ofcapital and theprice ofnon-traded goods adjustsluggishly; in contrast the nominal rateadjustsinstantaneously to exchange ensure that theconditions foruncovered interest in thepresence parity ofrational exchange rateexpectations are alwaysmet.The ability ofmonetary to stabilize theeconomy is policy examined, anditis shown that, evenwhenintervention isjustified in principle, errors policy which arisefrom confusing realand monetary shocksmayworsen macroeconomic performance.
I. Introduction
Despite, orperhaps becauseof,thelarge amount ofresearch devoted tothe study of macroeconomic stabilization policy,the 1970sfailedto produce anything likea consensus on thesubject. Muchoftherecent literature has focussed on providing fordeviations explanations from theclassicalnorm of perpetual fullemployment, and on analysing therobustness of various policy under prescriptions alternative the rationales for use ofsuchpolicy. Whileproponents of the "new Classical macroeconomics" have putforwardan equilibrium interpretation of thebusiness cyclein which no constructive role existsfor"Keynesian" demandmanagement, others have invoked wage-price stickiness as a justification forpolicyactivism. However,thisfocuson short-run demandmanagement has distracted attention from thelonger-run implications ofintervention through itseffects on investment and resource allocation. Thispaperattempts to redress the balancebyexploring theinteractions between exogenous shocks, short-run stabilization policy,and long-run resourceallocationin a model which
* We aregrateful to ourdiscussant, John Flemming, to other conference participants, andto Neil Bruce,Willem Buiter, Lars Calmfors and SlobodanDjajic forhelpful comments. This research was supported, in part, bytheCommittee forSocial ScienceResearch in Ireland.
Scand. J. of Economics 1982
230
J. P. Neary and D. D. Purvis
ofmoneytreatment with an explicit structure a richproduction combines The model expectations. exchange-rate and rational equilibrium market thereal that itwas shown (1981)where in Neary& Purvis was introduced reallocation intersectoral sluggish from arising of theeconomy adjustment itsnew ratemayovershoot exchange thenominal implies that ofresources all wagesand evenwhen realshock, an exogenous valuefollowing long-run lastassumppaperwe relaxthis flexible. In thepresent are perfectly prices themacroecobetween tionand thusare able to examinetheinteraction dynamics sticky pricesandtheMarshallian from resulting dynamics nomic factor reallocation. sluggish arising from we do policy, of stabilization effects Whileourfocusis on thelong-run as place in a vacuumbut rather as taking not conceiveof intervention The dynamic evolvingin responseto specificexogenousdisturbances. followboththe"natural"response thusreflects oftheeconomy response policy is Although to thepolicy. ingtheshockandthe"induced"response the of thedisturbances, theeffects to mitigate as intending characterized sucheffects. exacerbate actually it might waysin which suggests analysis have shockswhich is to analysetwodifferent exogenous Ourprocedure forresource implications long-run effects but different similar short-run forone maynotbe appropriate Policieswhichare appropriate allocation. thetwomaybe hard effects are similar, theother. for Yet, sincetheimpact this observable; are not directly if the shocksthemselves to distinguish the we consider, Ofthetwoshocks errors. ofpolicy leadsus toa discussion in theform of an equal percentage disturbance is a purely first monetary prices.The second is a "resourceboom" which increasein all foreign boom" this focus on a "resource allocation ofresources; thelong-run alters thespecifics oftherealmodel. underlies boomshave of resource and stabilization consequences The allocation model Corden& Neary(1982)use a three-sector elsewhere. beenanalysed the services-to investigate and non-traded -resources, manufactures, inthe ofoutput boomcan lead to a reduction a resource whereby channels labelled"de-industrialization" often a phenomenon manufacturing sector, a resourceor the "Dutch disease". Two mainchannelsare identified:
bids movementeffect,wherebythe booming sector directlyor indirectly
which anda spending themanufacturing effect sector, awayfrom resources services for the demand in manufacturing by raising squeezes profitability to nonrate(therelative therealexchange priceoftraded and so lowering in tradedgoods). Buiter& Purvis(1981) arguethatde-industrialization into oflabour movement a significant is notassociatedwith countries many the from therealappreciation stress arising and instead thebooming sector their model In domestic with prices. sticky boomin conjunction resource ofproducfor factors do notcompete directly and manufacturing resources henceno labour-market is takenas exogenous; output tionsinceresource
Sectoralshocksin a dependent economy 231 theforoccursinstead pressures emerge, and deindustrialization through eignexchange market.' The model used in this paper retainsthe three-sector framework of Corden& Nearybutmodifies theunderlying structure to reflect theBuiter & Purvis viewthat thedirect labour-market from effects arising expansion oftheresource sectorare minimal. is assumed Production oftheresource to require a specific factor in addition to capital, butnotlabour.Manufacturedgoods are producedusing capital and labour while servicesare producedusingonly labour. Labour is freely mobilebetweenthe two sectorsin whichit is used, manufacturing and services.In contrast, the it is used, benzine allocation of capitalbetween thesectorsin which and is fixedin theshort manufacturing, runand variable onlyin thelongrun. Thisproduction is combined structure with theassumption that theeconomyis "dependent" in thesense thatit is a pricetakerin themarkets for bothtraded goods;hencethedomestic demand oftheexogerepercussions nousshockshave direct influence onlyin theservices sector. The planofthepaperis as follows. Section1I sketches thedetails ofthe real modeland analysesits shortand long-run responses to a resource boom. SectionIII extends theanalysisto incorporate slow adjustment in therelative priceofservices, IV introduces while Section a macroeconomic framework and examines thedynamics thatarisewhenboththepriceof services and theallocation of capitalare slow to adjustwhilethenominal exchange rateis allowedto float. V then Section focusses on thekeypolicy issuesand SectionVI presents someconclusions.
II. Resource Allocation and Marshallian Adjustment in a Dependent Economy

In thissection we introduce thebasicproduction andconsumption relationshipsof thereal partof our model,and illustrate theresponses of output and resource allocation to structural shocks.We examine bothshortand long-run responses intheMarshallian sensethat somefactors ofproduction are fixedin the short runbut variablein the longrun.However,in this section we abstract from themacroeconomic distinction between short and longrunthat arisesinthepresence ofnominal pricestickiness byassuming perfect priceflexibility. TheModel The modelis characterized by threesectors;the economy produces one non-traded good (services)and two tradedgoods (manufactures and the
' A third approach is to emphasize theintermediate goodsaspectofresources, as is done,for example, byBruno& Sachs (1979)and Djajic (1980).However, thiscannot be central to the case treated herewhere a boomresults from a domestic ofa traded discovery resource.
232 J. P. Nearyand D. D. Purvis of is smallinterms theeconomy good,benzine).We assumethat resource ofthetwotraded prices currency ittakestheforeign so that markets world price,as given. relative goods,and hencetheir are intended of production thetechnology concerning The assumptions labourservicesare highly the stylizedfactsthatnon-traded to reflect labour.Accorduse verylittle sectors whileresource-extractive intensive andby labour, only to require theoutput ofservices, ingly, Xs, is presumed is set equal to coefficient choice of unitsthe input-output appropriate
unity.2 Xs = Ls (1)
throughout maybe identified priceofservices thedomestic Thismeansthat thewagerate: with Ps= W (2) withcapitalto producemanufactured Labouris also used in conjunction goods: XM= XM(KM,LM) V: factor, usingcapitaland a specific Finally, benzineis produced
XB = XB(KB, V)
(3)
(4)
mobile We assume thatlabouris in fixedsupplyand instantaneously we also In this section sectors. manufacturing and services the between condition (5) is always givenbyequation assumethatthefullemployment satisfied.3 LM+Ls = L (5)
for sectorsthuscompetedirectly Whilethe servicesand manufacturing labour,thereis no such directlinkbetweenthe servicesand resource does notuse labour.Thereare, ofcourse,indirect sincethelatter sectors which is for themarket andbenzine capital, services through links between andmanufactures. However, capital ofbothbenzine usedintheproduction through slowly in theshort run,and can onlybe adjusted is a fixedinput of this Details return. its in adjustto timein response changes perceived later. until are postponed mechanism ment is a Sincethecountry side ofthemodelis straightforward. The demand domestic manufactured markets for inworld goodsandbenzine, price-taker
2
3
use ofthisassumption. See Kouri(1979)foran earlier level" ofemploya "natural one specifying with III we replacethisassumption In Section can fluctuate. actualemployment aboutwhich ment
Sectoralshocksin a dependent economy 233 demand forthesegoodsplaysno roleindetermining their oroutput. prices In contrast, priceand quantity in themarket forservices are influenced by domestic demand. Domestic demand forservices, uponprices Cs, depends and realincomeY as shownin equation(6) wherethesignsof thepartial derivatives are as shown: CS = CS(PS, PM, PB,Y)
_ ? ?
(6)
If servicesare net substitutes for manufactures and benzine,the two uncertain signswillbe positive; we assumehenceforward forconcreteness that thisis thecase. In latersectionswe will examinemacroeconomic phenomena usinga framework in which nominal pricesare determined. we confine However, ourattention in thissection and thenextto "real" variables. Hence only relative pricesaredetermined; national income andexpenditure are always equal,implying a zerotrade at all balance times. Forthepresent we choose manufactured goodsas numeraire, and define therealexchange rate, r,as therelative priceof manufactures in terms of services:
W I=PM/PS = PM/ (7)
Movements in therealexchange rateare simply theinverse ofmovements intherelative priceofservices intherealwageratefaced or,equivalently, bythemanufacturing sector. We wishto examine howtheoutput ofthethree goodsandtheallocation offactors to a resource respond boomintheform ofan exogenous increase in either the worldpriceof benzineor in the availablesupply of V, the specific factor usedintheproduction ofbenzine. To do so, we first examine the determination of equilibrium and thensee how thatequilibrium is perturbed by a resource boom.(Technical detailsand derivations maybe found in theAppendix.) LabourMarket Equilibrium In Fig. 1 the combinations of the real exchangerate and the sectoral allocation ofcapitalconsistent with labour market equilibrium are depicted bythecurveLL. An increase inAr, which is a fallinthemanufacturing real wage,increases thedemand forlabourin themanufacturing sector.A rise in ris equivalent to a fallinPs so that thedemand forservices, and hence forlabourin the servicessector,rises as well. An increasein :r leads, therefore, to an unambiguous increase in thedemand forlabour.A reduction inthecapitalstockinthemanufacturing sector would, at a given wage, lead to a reduction in thedemand forlabourin themanufacturing sector. Hence the labour market equilibrium locus LL is negatively sloped as
234 J. P. Nearyand D. D. Purvis

7r L EDL
EDK
ESL EDK
EDL ESK
ESL K
. -
ESKL
lo wKM
KM
equilibrium. Fig. 1. Factormarket
for to excess demand above thelocus correspond shownin Fig. 1; points labourand pointsbelow to excess supply.Note thatLL also depicts forservices. in themarket equilibrium Equilibrium CapitalMarket of timethecapitalstockin boththemanufacturing Whileat any moment in stocks thecapital inthelongrun is predetermined, sectors andresources we this In paper ratesofreturn. adjustso as to equalizetheir bothsectors so is fixed intheeconomy ofcapital thetotalstock thecase where consider from capital reallocating processinvolves that thecapitalstockadjustment one sectorto theother:
KM+KB= K
(8)
model of of the Heckscher-Ohlin This of course followsthe tradition earlier we follow adjustment slow,costly trade.In postulating international by Mayer(1974),Mussa (1974,1978)and Neary(1978).4 work in therealexchange increase of a permanent theimplications Consider r raisesprofitabilin An increase of allocation capital. rateforthelong-run to capitalin that return and so raises the long-run ityin manufacturing in to capital thereturn is to be restored equilibrium Ifcapitalmarket sector. thatcapitalallocatedto thebenzinesectormustalso rise,whichrequires market locus,KK, equilibrium decrease.Hencethecapital must that sector and conto excess demandforcapitalin manufacturing, corresponding below. forpoints versely
4 In Neary & Purvis (1981) we also examine the case where physical capital is mobile so thatthe total stock of capital in the countryis endogenous. internationally
is positively sloped as depicted in Fig. 1, with points above the line
Sectoralshocksin a dependent economy 235

7r
K'
~L
/A
/K
K1
7r,
' K1 KM
-
~~~~~~B
K0~~~~~~P
M
Fig. 2. Comparative statics and Marshallian dynamics.
Statics Long-Run Comparative of a "resourceboom" due to either a "discovnow theeffects Consider in thepriceof V or an increase factor ery" of new stocksof the specific demand is an increased for benzine, pB.5 Since real incomerises,there demand forlabourin theservices which to an increased services amounts for inmanufacthedemand labour thelabour sector. To equilibrate market, rateand henceat givenfactor turing mustfall;at a givenreal exchange a reduction in capitalin the proportions, this is accomplished through shifts the manufacturing sector.The LL curve therefore left,reflecting theboomraisestherateofreturn oftheboom.In addition, effect spending to capitalin thebenzinesector fora long-run reallocation ofcapital calling benzine. HencetheKK curvealso shifts towards awayfrom manufacturing effect oftheboom. theresource-movement left, reflecting This is illustrated in Fig. 2 wherethedashedlinesLL and KK replicate theinitial equilibrium locifrom Fig. I andthesolidlinesL'L' andK'K' are the new loci following the boom. The stockof capitalin manufacturing falls.The realexchange ratemayriseor falldepending unambiguously on whether the KK or LL curveshifts more;in the figure we illustrate the moreplausible thespending intuitively case where effect dominates and so thenewlong-run equilibrium at C is characterized by a realappreciation.
can be identified with intheforeign relative ofbenzine a boomonly ifthe 5 An increase price in itspriceamounts of benzine, so that an increase to an improveis a netexporter country ment intheterms oftrade.Such a priceincrease also has a cross-price on thedemand effect ifbenzine for which is positive andservices arenetsubstitutes ifandonly indemand. services, we assumethroughout For ease ofexposition thepaperthat boththeseeffects are positive, to allowforalternative ourresults are easilymodified although assumptions. See equations forfurther details. (A. 1) and(A.4) in theAppendix
Sand. J. of Economics 1982
236
Marshallian Dynamics
boominvolves a rea resource following equilibrium Whilethelong-run runthecapitalstockis in theshort ducedcapitalstockin manufacturing, there is no resource-movevalue,K?. Hence on impact at itsinitial fixed A to B in Fig. 2. Thereis an and the economymovesfrom menteffect to capitalrises in the while the return real appreciation, unambiguous It is clearthatthis sector.6 manufacturing in the and falls sector resource thesimple we postulate forcapitalreallocation; givesriseto an incentive adjuststhrough the capitalstock in manufacturing whereby mechanism earnedby capitalin thetwo in therentals to differences timein response :7 sectors
KM = (F(rM/rB) (( 1()= O, P> O (9)
process adjustment thecapital describes Thiscompletely since,byequation by an sectoris matched (8), a changein thecapitalstockin theresource changein thecapitalstockin manufacturing. equal and opposite after adjustment thedynamic clearscontinually, Sincethelabourmarket to B takesplace alongtheL'L' curve.The economy thejumpappreciation path along whichKM steadilydeclines followsa monotonic therefore in bythearrows as indicated realdepreciation, bycontinuous accompanied it rateinthat oftherealexchange there is "overshooting" Fig. 2. Notethat until itreaches thereafter risescontinually to :r and then fallsimmediately rate is ofthereal exchange valuefr. Thisovershooting itsnewequilibrium shortitoccursdue to a real rigidity-the inresponse to a real disturbance; the withthe capitalstockfixed, runfixity of the capitalstock.Initially, runthe is bornebytherelative price;inthelonger brunt oftheadjustment in price. therequired adjustment in thecapitalstockmitigates adjustment and long-run of shorttheMarshallian analysis This,of course,is exactly to a changein demand. adjustment rate ?rO so that exchange In thefigure, both;r1andftare belowtheinitial thelongbutexceedsinmagnitude direction is intheright theinitial change to is largerelative effect theresource-movement runchange.If,however, then inthelongrun, there is a realdepreciation so that thespending effect, runtherealexchange intheshort rate, byfalling, than overshooting, rather movesin the"wrong"direction.
6 The latter occurs since on impact labour moves frommanufacturing to services so the
rises. capital-labourratio in manufacturing 7 Mussa (1978) postulatesa more satisfactory but morecomplicatedprocess wherebythe rate of capital movementdepends on the present value of expected futurerents less the costs in reallocatingcapital. incurred
III. Marshallian with Adjustment

Relative Price Rigidities
In theprevious & Purvis section, following Neary (1981),we considered the shortshockunder and long-run to a sectoral theassumption adjustment that domestic In thepresent pricesare instantaneously flexible. section we allowforthepossibility that therelative priceofservices adjusts sluggishly in response to imbalances between and demand. thatan supply Recalling increase in therealexchange is equivalent to a fallin therelative rate, sr, priceof services, we maywrite:
r= W(XSICs) I(1) = 0, '>0 (10)
Since labouris the onlyfactor used in the servicessector, equation(10) maybe interpreted as either a labour-market or a services-market adjustment mechanism.8 Thusthepresence ofnon-market intheservices clearing market is equivalent to a departure fullemployment from withthe wage rate adjusting slowlyto eliminate underor over-full employment. The L in equation(5) in the last sectionshouldtherefore parameter now be interpreted as the " natural"rate of fullemployment rather than as a binding constraint whichcannotbe exceededin theshort run.In order to theanalysis simplify we ignore thefactthat departures from this"natural" level maycause either firms or households to face quantity constraints, forcing them to recalculate their decisions on other markets inthemanner familiar from Clower's"dual-decision hypothesis". Hence ouranalysis is strictly applicable onlyin theneighbourhood offull employment, although for theissueson which we wishtofocusthis omission is nota crucial one.9 Whilein thepresent sectionwe allowforsluggish relative priceadjustment, the modelis stilla real one in whichnominal magnitudes are not determined. The dynamic evolution ofthesystem can therefore be illustrated in Fig. 3, whose essentialfeatures are identical to thoseof Fig. 2. However, theeconomy is no longer constrained to lieon thelabour-market equilibrium locus L'L'. Recall thatpointsabove thislocus correspond to excess demand forservicesand henceto upward pressure on their price, and conversely forpoints belowthelocus; theresulting tendencies forthe real exchangerate to adjustare indicated by the vertical arrowsin the diagram. As shownin the Appendix (see equationA.20), the system is globally stable;whether or notit generates cyclicaladjustment pathsdeThe implications of sluggish priceadjustment have beenstudied in open-economy models by,among others, Dornbusch (1976)inthecontext ofgoods-market adjustment andNoman & Jones (1980)in thecontext oflabour-market adjustment. 9 Thisamounts to ignoring theincome effects on thedemand forservices andmoney caused bydepartures from full-employment. Theconsequences of"disequilibrium" spillovers inopen economies havebeenexplored byDixit(1978),Liviatan (1979)and Neary (1980).
8
238
J. P. Neary and D. D. Purvlis

L'
~~~~~~~~~K'
7r?_
A
A
\
1,~~~~
B K K
M L'
KO
Fig. 3. Simultaneousadjustmentof the capital stock and the real exchange rate.
modeland on the relative of the long-run pendson boththe parameters equations (9) and (10). in theadjustment speedsembodied adjustment from The response to a boomis noweasilydetermined of theeconomy A, theboomgivesrise at point long-run equilibrium ininitial Fig.3. Starting capitaloutof to reallocate and an incentive forservices to excess demand in case analysed unlike theflex-price sector.However, themanufacturing B. to point immediately does notshift theeconomy section, theprevious ofA. on a continuous pathto thesouth-west theeconomy starts off Rather, to which thereal theextent mitigates therefore priceadjustment Sluggish itslong-run value. rateovershoots exchange theeconomy adjustgradually, Whenboththelabourand capitalmarkets A to C as inthedotted pathin Fig. 3, or cyclically from maymovedirectly relative as in thedashedpath.The sloweris thespeedofpriceadjustment is thedirect themore path.Hence likely reallocation, tothespeedofcapital in overshooting (1976) analysisof nominal in contrast to the Dornbusch a "stabirelative prices provide disturbances, sticky to monetary response rate.'0 on the(real)exchange lizing"influence to Monetaryand Real Shocks IV. MacroeconomicAdjustment for mechanism a sluggish In theprevious section we postulated adjustment therealexchange rate,z. Howeverno accountwas takenofthefactthat reflect priceof servin thisvariable changesin boththenominal changes
"' We have restrictedour discussion to the "plausible" case of long-runappreciation. If effectis a rise in r, then inevitablytheremust be at least one turning instead, the long-run pointin r duringthe adjustment.
SC(and.J. of Economics 1982
Sectoralshocksin a dependent economy 239 ices, Ps, and thenominal exchange rate,E, and thatthedeterminants of thesetwocomponents are likely to be verydifferent. of (7) Thus,instead we maywrite:
EPf{P5 (I 1)
where Pf is thepriceof manufactures in foreign assumed to be currency, determined. Dornbusch exogenously Following (1976),we assumethat the nominal priceof domestic moves goods imbalances slowlyto eliminate between and demand. supply Hence (10) is replaced by: Ps=W(CsIXs); W(1)=0, II>0 (12)
By contrast, thenominal exchange rateis assumedto be determined by therequirement ofstockequilibrium inthemarket for in foreign exchange, an environment whereexchange-rate expectations are formed rationally and domestic and foreign assets are perfect interest-bearing substitutes. The latter assumption implies thatdomestic and foreign nominal interest ratesare linked by theuncovered interest parity condition givenby equation(13). i= if+E (13)
E is theexpected proportionate rateofchange ofthenominal exchange rate which, given theassumption ofrational expectations, equalstheactualrate of change.Equation(13) thusshowsthatthe domestic interest ratecan exceed the foreign rate onlyif thereis an expecteddepreciation of the domestic currency. The demand forrealbalancesdependson realincome and thedomestic nominal interest rate:
MIP = WD( Y,i) (14)
The price level P is a linearly homogeneous function of all final-goods pricesand henceincreases with thenominal exchange rate.An increase in thenominal exchange ratethus givesriseto a fallinrealbalances;this must be accompanied bya riseini ora fallin Y inorder for monetary equilibrium to be maintained. The valuesofi andE which are consistent with monetary equilibrium forgivenvalues of M, Ps and Y are thusdepictedby the positively slopedlocusMM in Fig. 4. In thelongruntheratio ofE toPs is determined by theconditions forrealequilibrium outlined in SectionI and so, for a given M andwith realincome at itsfull-employment level(contingent on givenvaluesoftheexogenous variables), thevalueofPs adjusts to ensurethatequilibrium of thereal and nominal sectorsis simultaneously attained. Such a long-run equilibrium is illustrated bypoint Z in Fig.4: the
240
if
Z/
P.E
Fig.4. Longrun equilibrium determination oftheinterest rateandthenominal exchange rate.
domestic interest rateequals theforeign interest rateso theexpected and actualchange intheexchange ratearezero,andtheactualexchange rateis equal to thelong-run rateE. Noticefinally that, unlike therealmodels ofSections I andII, thecurrent accountneed notbe in balanceexceptin long-run equilibrium. Hence the levelofdomestically-held wealth changes throughout theadjustment period and national expenditure and income are notequal. However, rather than inorder complicating themodelfurther to consider theseissues,we follow themfrom We now examinethe earlierworkin omitting consideration. a monetary shockand a dynamic responsesof the fullmodelfollowing resource boom,respectively. A Monetary Shock in thedomestic reduction an unanticipated once-and-for-all Consider first the nominal exmoneysupply." In the long runthis shock is neutral; to the changerate and the domestic priceof servicesfallin proportion in the moneysupply.In Fig. 5 the new long-run reduction equilibrium rateequal to E, where(E-EO)/E1 occursat Z, withthenominal exchange there is excess On impact fallin themoney equals thepercentage supply. MM shifts leftwards. so demandformoneyat the initial equilibrium ZO ofthereducleftwards MM mustshift Moreover by morethantheextent the a sticky nominal sincewith tioninthemoney supply, priceofservices, in orderto nominal exchangerate mustfall morethanproportionately forgivenvalues of Y and i. WithPs restore money-market equilibrium
in thelevelof foreign as changes shocksare modelled the paper,monetary 'l Throughout the to consider supply, butthemodelmayeasilybe extended money or thedomestic prices along thelines monetary ordomestic inflation intherate offoreign ofchanges growth, effects (1981). & Miller (1982)or Buiter & Purvis ofBuiter
ZI
.1,
Z?0
M
~~M-
Fig. 5. Short-run equilibrium and exchange-rate dynamics following monetary deflation.
locus M'M' must givenat its initial equilibrium value,the money-market ofZ, as shown in Fig. 5. lineifto theleft therefore cutthehorizontal themoneWhiletheequilibrium valuesofE and i immediately following tary lie alongM'M', thedetermination of their contraction musttherefore Ifthepriceofservices a moredetailed is location precise requires analysis. the onlyvariablewhichadjustssluggishly then,as shownby Dornbusch (1976), the new short-run mustlie at a pointsuch as Z', equilibrium a rise in the domestic implying interest rateand an overshooting by the nominal rateof its new long-run value. Fromthecondition for exchange interest uncovered interest rateis possible parity, equation(13), a higher setthecurrent is expected therefore onlyifthere depreciation. Speculators theactualadjustment ratebelowitslong-run valueso that of spotexchange theexchange rateis consistent with and theexchange theseexpectations, raterisesmonotonically the adjustment it reachesits during perioduntil newlong-run value. Note that thisis a case ofovershooting equilibrium of thenominal exchange rateinresponse toa monetary shockandcausedbya nominal in sharpcontrast to the real overshooting rigidity, discussedin SectionII. Howeverwhenboththe priceof servicesand theallocation of capital theanalysis adjustslowly, ofthemodelis considerably morecomplicated. Thereis stilla presumption thatthenominal rateovershoots exchange its long-run value but the adjustment path whichit followsneed not be as shownin theAppendix. monotonic, One possiblepathis illustrated by thedashedlinefrom Z" in Fig. 5. If theadjustment pathis cyclical thenit mustconverge in a clockwise fashion as shown,sincefrom equation (13) phases of depreciation mustbe associatedwithvalues of the domestic interest ratewhich are above thereturn availableon foreign securities. Corresponding to theadjustment of nominal variables illustrated in Fig.
16-824815 Scand. J. of Economics 1982
242
J. P. Nearlyand D. D. Purvis
priceof domestic sincewitha sticky are also adjusting, 5, real variables At Z" therelative has real effects. deflation the initial monetary services rise to excess supplyin thatsector. priceof serviceshas risen,giving to fall;thisin turn to equation(12) thepriceof servicesstarts According rate. tendsto raise real balances and to reduce the domesticinterest is a risein thereal priceof services relative to thehigher Corresponding the labourcapitalfrom to reallocate wage. Hence thereis an incentive the initial sectorto the resourcesector,and during usingmanufacturing level. processXMfallsbelowitssteady-state stageoftheadjustment
A Resource Boom
of a resourceboom were analysedin Section real effects The long-run the real effect oftheboomtends toreduce II where thespending we sawthat tendsto raise it. effect exchangerate whereasthe resource-movement ratethrough exchange on thenominal working effect Thereis an additional (14); this we call the liquidity condition equilibrium the money-market price a fallinthedomestic theboomrequires realincome, By raising effect. a rate,implies realexchange witha constant levelin thelongrunwhich, Hence we takethisto be the"expected"outcome, appreciation. nominal (A.25) in the forthechangein E (equation as thefullexpression although or not this actuallyensues dependson the Appendix)shows, whether ofthemodel. parameters in the and real appreciation to the case of nominal attention Confining mayagainbe illustrated in nominal variables changes theinduced longrun, adjustsinstantaneously, theaid of Fig. 5. Whenthepriceof services with ratemayovershoot thenominal exchange (1981)showthat Neary& Purvis is reallocated as capital depreciation bya steady valuefollowed itslong-run is illustrated bytheshortsector.Thispossibility outofthemanufacturing interest rate thedomestic on impact, at Z' in Fig. 5 where, runequilibrium thiscan occuronlyifthere condition theinterest parity has risen.Butfrom of the domestic currency. of depreciation expectation is a simultaneous ratebelowits set thecurrent willtherefore exchange Rational speculators must be there fallsthen rateitself exchange value; ifthelong-run long-run and the of services both the capital When price short-run overshooting. of boththe real and nominal initial overshooting stockadjustsluggishly, ormonotonic with cyclical subsequent ratesis againa possibility, exchange thenewlong-run towards equilibrium. movement betweenSectoral Adjustment V. Interactions and MacroeconomicPolicy intheabsence model has beento developthecomplete So far ourobjective ofhowpolicy to thequestion we turn section In thepresent ofintervention.
Sc and. J. of Economics 1982
M / ///
f*
/M
/
M
Ml [
-
E0
|I*E
Fig. 6. Inappropriate response to a foreign priceshock.
its to stabilizethe economyin the shortrunmay affect rulesintended longer-run adjustment. Rate Movements Inappropriate Responsesto Nominal Exchange whichif properly a foreign We beginby considering price disturbance ininitial from theauthorities. perceived requires no response Starting longtheworld ofbothtraded at ZOin Fig. 6, supposethat runequilibrium prices amount.If therewere no policy goods increaseby an equi-proportional fallin at Z., witha proportionate response, thenew long-run equilibrium and thedomestic no realchanges evenin theshort run, currency pricesof inPs is required, all three Sinceno change goodswouldremain unchanged. no dynamics are elicited.'2 in moving from entailed However thenominal appreciation ZOto Z, may a real thatit will also imply be resisted, perhapson the false grounds of thedomestic tradedappreciation leadingto a loss in competitiveness of course, since the nominal goods sector. Such a view is incorrect, the is in responseto a foreign appreciation pricerise,and so is merely inline.However, ifthe is kept process bywhich domestic competitiveness the sourceofthefallin thenominal rateis notclearly exchange identified, withone wherea nominal does situation be confused might appreciation
2 The new long-run equilibrium is attained instantaneously becausein our modeltheonly rolefor theexchange rateis to convert into foreign prices domestic units andhence currency only theproduct ofE andtherespective Iftheexchange foreign prices matters. rateplayed an additional role,forexample in converting foreign denominated assetsinto domestic currency units which then influenced realspending, theresults couldbe substantially different. See, for example, Calvo & Rodriguez (1977)or Purvis (1979).
There would be theexchange rateto E,, would be attainedinstantaneously.
244
7T
L ~77
_ CM
I+
K L M
KM
Fig. 7. Real adjustment to inappropriate monetary intervention.
thatthedomestic Supposefirst wereraisedin proportion money supply to theforeign pricerise. This wouldmeanthatthe long-run equilibrium wouldremain at ZOin Fig. 6 and thelong-run exchange ratewouldremain at E0. But in theshort runwith there wouldbe an excess supply Ps given, of moneyat ZO. The MM curve shifts to M'M' and the short-run right equilibrium moves to a pointsuch as Z2. Dynamicadjustment involves instantaneous inE and :T followed increases byeither continuous appreciationcombined with in thepriceofdomestic increases services (as depicted in Fig. 6) or by cyclicaladjustment of all nominal variables. The policy mistake results in "importing" theforeign sinceall domestic priceincrease are higher prices at ZOthanat Z1 (where wereinfactunchanged), and they in a misallocation of resourcesduring the adjustment periodsince both nominal and real exchangerates differ fromtheirlong-run equilibrium values. The real adjustment is illustrated in Fig. 7; the initial and final are bothatA andtheshort-run equilibria equilibrium immediately following themonetary intervention is at B. It is clearthat there is at leastone turning intheadjustment ofKM, andinfact ofboth rand point cyclical adjustment KM is also possible. An alternative intervention fixthe form ofmonetary wouldbe to simply an instantaneous nominal rateat Eo in Fig. 6. Thiswouldinvolve exchange inthemoney on thepriceindex increase totheimpact supply proportionate oftherisein thetraded-goods price(i.e., a less-than-proportionate change in M). There would thenbe excess demandfor servicesleadingto a sufficient to continuous risein Ps matched by a risein themoney supply In terms variables in Fig. 6 of the nominal keep real balancesconstant.
S and. J. of Economics 1982
appreciation.
harm thecompetitive position ofthedomestic export sector.Let us examine the implications of usingmonetary policyto "offset"the nominal
Sectoral shocks in a dependenteconomy
245
there remains at Z0 throughout. are no dynamics as theeconomy However realadjustment increase intherealexchange still involves an instantaneous ratefollowed realappreciation byeither continuous or a clockwise cyclical in Fig. 7 where path.The former case is illustrated theshort-run equilibriumis at pointC which a smaller realdepreciation thanwhenthe involves in proportion money supply increases to theforeign priceshock.
InappropriatePolicies and a Resource Boom
In thecase of a foreign pricedisturbance just considered, theappropriate response on thepartofthemonetary authorities was toforego intervention and let the foreign-exchange market to the shock.By adjustcompletely contrast, in thecase ofa resource boomthesluggish ofdomesadjustment ticprices provides a rationale forintervention: someofthetransitional loss of outputand employment could be avoided by a monetary expansion whichwould mitigate the initial rises in the real and nominal exchange rates.'3This assumeshowever thatthe authorities correctly identify the sourceoftheinitial Ifthey appreciation. failto do so then inaction by they in effect toleratethe transitional unemployment attributable to the deindustrialisation effect of the boom. Worse still,if monetary policyis targeted towards exchange-rate stability rather thantowards internal balance it mayexacerbate the medium-run costs of theboomand delaythe 14 attainment ofthenewlong-run equilibrium. These issuesare illustrated in Fig. 8 which repeats theessential features ofFig. 3. Starting in initial equilibrium at A theboomleadsto a newlongrun equilibrium at C. With thesectoral allocation ofcapital andthenominal price of servicesfixedin the shortrun, speculative behaviour in the absenceof intervention mayinducea severenominal appreciation which shifts theeconomy to point F, causing therealexchange rateto overshoot bothitsnewlong-run equilibrium leveland theshort-run equilibrium level which wouldobtain at B ifcommodity priceswereflexible. The boomthus gives rise to a decline in competitiveness of the manufacturing sector accompanied by a risein unemployment. Once againa cyclical adjustment pathis possible,although forsimplicity we concentrate on the case of monotonic adjustment.'5
'3 In adopting this traditionalKeynesian view of the desirability of intervention we are ignoring the possibility thatthe priceadjustment equation (12) mayembodya rationalresponse to a changingeconomic environment, in whichcase it would not be independent of the policy rule adopted by the authorities. 14 Throughout this section we assume that monetarypolicy takes the formof a relatively small number of once-and-for-all changes in the money supply, ratherthan a policy of continually changingthe money supply. '5 Still more complicated adjustmentpaths (withoutany jumps in the exchange rate) would ensue ifspeculatorsforesee such interventions. The effects of anticipatedfuture disturbances on the adjustmentpaths of models with rationalexpectations have been studied by Wilson (1979) and Buiter& Purvis (1982).
246
7r
je
L~~~~~~~~~~
KA
M M
Fig. 8. Appropriate and inappropriate response to a resource boom.
One optionopen to theauthorities in thiscase is to expandthemoney supply so as to partly offset theinitial appreciation. Such a strategy could forexamplebe targeted offull on therestoration employment in theshort run,implying a move from A to B. At B foreign-exchange speculators wouldchoosea pathforthenominal exchange ratewhich wouldlead to a convergent movement towards the new long-run equilibrium C. Without is still further intervention someunemployment thetransition during period inevitable, butitsextent is less than alongtheno-intervention pathstarting at F. B willbe attained However thehigh employment paththrough onlyifthe and the source of the initialappreciation authorities correctly identify recognize the desirability of responding to it witha policywhichpartly thattheauthorities theinitial offsets appreciation. Supposeinstead acquithe tocounter esce intheinitial andthen appreciation subsequently attempt is rates.One possible outcome andrealexchange riseofthenominal steady the assumesthat F to C in Fig. 8 which illustrated bythejaggedpathfrom from should be shielded that theeconomy inthemistaken belief authorities, the twiceintervene thesteadynominal and realdepreciation, by reducing the effect this It is clear that of manner. in an money supply unanticipated and to of thelong-run intervention is to delaytheattainment equilibrium the thaneither and loss ofoutput lead to moretransitional unemployment F to C) from a steady monotonic no-intervention path(implying adjustment or thehigh-employment B to C). path(from
Sectoralshocksin a dependent economy 247 VI. Conclusion domestic a modelin which In thispaperwe have presented pricesdo not and demand. between Withto imbalances respond instantaneously supply out examining the microfoundations of this price-stickiness, we have a justification forgovernment interin principle, assumedthatitprovides, do notadjustimmedimarkets factor vention. Howeverbecause domestic with similar short-run ately toexogenous shocks, disturbances impacts may an intervenhavevery different long-run effects. Hence,as we haveshown, thesourceofa disturbance tionist government whichis unableto identify theeconomy's whichexacerbates mayrespond in a manner performance and slowsthereturn to long-run equilibrium. In ourviewit is theriskofpolicyconfusions ofthissortrather thanthe themajorobjecwhich constitutes undesirability ofactivist policyin itself tionto a strategy of "fine-tuning" themacro-economy. Thisis notto deny of thatthe authorities the effects can and shouldtake actionto offset of and clearly shocks.Butthey should be conscious significant identifiable have thesame short-run theneedfordifferent to shockswhich responses In particular, movements arevolatile effects. wheninternational and capital exchange-rate expectations ina rational theauthorities are formed manner, shouldnotattempt in theexchange ratewhich are an to offset movements a newlong-run essential oftheadjustment realequiconcomitant towards librium. Finally, although we haveconcentrated in thispaperon monetary intervention whichcan onlyaffect theadjustment path,it is clearthat the same principles which can also influence also applyto fiscalintervention theeconomy's long-run realequilibrium.'6
Appendix This appendix presents theprincipal equations of themodeland sketches thederivation oftheresults. Further details on theflexible-price case may be found in Neary& Purvis(1981).Exceptwhere otherwise all indicated, variables are measured as natural logarithms, denoted by lower-case symbols (e.g., e=lnE), and expressed in terms ofdeviations from their values in theinitial equilibrium. (Thisis equivalent to choosing units ofmeasurementsuch thatthe initial equilibrium levels of all variables are equal to unity.) Exceptwherenoted,all coefficients are defined to be positive.
16 As noted byDixit(1978)and Neary (1980)thisis only thecase iftheintervention takesthe form ofgovernment purchases ofnon-traded goodssince, with exogenously given world prices of tradedgoods, intervention in tradedgoods markets effectively bypassesthe domestic economy.
248 J. P. Nearyand D. D. Purvis A. 1. TheReal Model The demandforservices,whichis also thatsector'sdemandforlabour used there), (since labouris the onlyfactor dependson pricesand real
income:
CS = --SPS+?BPB+6MPM+91Y
(A. 1)
The compensated elasticities ofdemand restriction ei obeythehomogeneity

(CB+
world pricesby thenominal exchange ratee:

=pfe p i=BM
EM =
5),
and the domestic prices of tradedgoods are relatedto their (A.2)
Real income, y, is defined as nominal incomedeflated by the consumer

price index,p:
P= /BPB+/MPM+#SPS
(A.3)
where the/3's are expenditure shares. In the present paper we consideronlytwo sourcesof changein real income: an increase in V, theendowment first, ofthespecific factor usedin the benzinesector(whose impact dependson the shareof thatfactor in national incomeOv); second, an increasein the worldrelative priceof benzinewhichraisesreal incomeon theassumption thatbenzine is a net export(so thatits share in nationalproduct, OB, exceeds its share in national expenditure, #B):
Y =V +(OB n-B) rB
(A.4)
We have introduced the symbol to denotetheterms of trade,and for 7rB 7r as therealexchange lateruse we define rate:
;rB =!P'-PfM = PB PM a PM-PS = e+p{m-W
(A.5)
(A.6)
The demand forlabourin manufacturing on thequantity ofcapital depends locatedthere and on therealwagefacing manufacturing firms:
im= kM-YM(W-PM)
(A.7)
YMis thewageelasticity where in manufacturing. ofthedemand forlabour Thisin turn in theservices is related to thelevelofemployment sector by thefull-employment constraint forlabour:
ALM IM+ ALS IS =0
Scandl(I.J. of Ecooinics
(A. 8)
1982
Sectoral shocks in a dependenteconomy
249
i used in sector. Fromequation where offactor (1) in ALjis theproportion in the servicessectormaybe identified thetextthelevel of employment and supply of services demand withthatsector'soutput. Hence equating thatw=ps), we obtain an and substituting earlier from equations (recalling thelabour-market of expression for equilibrium locus,LL inFig. 1,interms kM, wand exogenous shocks:
ALkM+Er+al = 0
(A.9) (A. 0)
(A.11)
where:
AL YM+CS > O;
AL ALM/ALS
and
al-?l0vV?
{CB+/1(0OB B)} JTB
In thedefinition oftheexogenous disturbance given byequation (A. I 1) the coefficient of TB is thecompensated ofdemand forservices cross-elasticity with respect to thepriceof benzine, effect adjusted fortheterms-of-trade on realincome. The capital-market locus is foundin a similar manner equilibrium by relating thedemands forcapitalfrom thebenzineand manufacturing sectorsby thefull-employment constraint forcapital:
AKB kB+AKMkM
=
(A.
12)
The demand forcapitalin thebenzinesectordependson thestockof the resource availablethereand the real rental the sector(whereYB facing denotes therental ofcapitaldemand): elasticity
kB= V- YB(rB-PB)
(A. 13)
In long-run in thebenzinesector therental equilibrium must equal thatin thelatter is related to thewageratebytherequirement manufacturing; that thepriceofmanufactures must costs: just coverunit
PM=
OLMW+OKMrM
(A. 14)
whereOijis theshareoffactor i in thevalueofoutput in sector j. Setting and combining theseequations with thecapital-market (A.2) yields equilibrium locus:
rM=rB YB IKkM
L7r+a2
=;
AK
AKM'IKB'
OL
OLMI0KM
(A. 15)
where:
a2
Y-1
V+2TB
(A. 16)
250
Thisis depicted by thepositively slopedKK curvein Fig. 1.

A.2. Long-Run Comparative Statics and DisequilibriumDynamics
The long-run equilibrium valuesofkM and r maybe found bysolving (A.9) and (A.15):
A kM -(OLaI+Ea2)
(A. 17) (A. 18)
A -ft-B
_AK a I+AL a2
where:
A=AALL+YBAKE
> 0.
(A. 19)
theattainment oflong-run For givenvaluesof theexogenous variables, is brought equilibrium aboutby thedynamic adjustment equations (9) and (10) in the text.These may be written as a matrix differential equation, whereq and V denotethe speedsof adjustment of thecapitaland labour markets, respectively:
[kM] [ -
AKIYB T6iz]
[kM-kM]
(A.20)
A>0 The determinant of the coefficient matrixin (A.20) is given by pTVy-'
and the traceequals -{lpe+qAKy-'}<0. Since thetraceand determinant stable. thesystem is globally are satisfied, conditions arise further effects that there are income theadjustment During period, as capital is reallocated from less to more productive use; see Neary (1982). inouranalysis. one are neglected effects These second-order Alternatively so thattheir as beinganticipated could considerthese incomeeffects as measured theinitial disturbance valueaugments capitalized by a,.
A.3. Money Demand and the Nominal Exchange Rate
The money-market condition as follows: equilibrium (12) maybe written

m-p
=
ty-_6li
(A.21)
oftheinterest i denotes thelevel,notthelogarithm, (Notethat rate.)Using (A.2), (A.5), and (A.6), thepriceindexgivenin (A.3) can be rewritten:
p = e+pM +/B aB /35J (A.22)
inthe a uniform a changeinpf implies .7r constant, Note thatwith change foreign prices of both tradedgoods. Equations (A.21) and (A.22) may now values of e and r, the long-run be combinedto obtain a relationship linking
Scand. J. )fEconlomli(cs 1982
Sectoralshocksin a dependent economy 251 in long-run thati equals iJ' for y from(A.4) and recalling substituting equilibrium:
e/37r + a3
=0
(A.23)
where:
=~ +O+1NIT__-"+f
(A.24)
thiswith an expression thelong-run for (A.6) and (A. 18) yields Combining valueofthenominal rate: exchange The threechannelsby whichthe nominal exchangerate is affected by to thespending, shocks, exogenous respectively a,, a2 and a3, correspond resource-movement and liquidity effects in thetext. discussed A.4. Exchange-Rate and Saddle-Point Expectations Stability the exchangerate in logarithmic interest form,the uncovered Writing condition (13) becomes: parity i =~(A.26) if+~~~~~~~~~~~~~ Whencombined with(A.21) thisyieldsa third differential equation.The as follows: dynamic system maybe written
k
PS ~~
J
-OY-IAK q!OO
VAL
P0L
iF
k
P
_-iVE
613s 6(1l#s)JL_
VEt~
PS -
(A.27)
the coefficient matrix in (A.27) by A, we wishto solve forits Denoting characteristic are thesolutions which to thecharacteristic roots, equation:
flu) = I-A+MII =MY3-a2 2+alu-a0=0
(A.28)
where thecoefficients are defined as follows: pA >0 ao0=JA I=qOV al = /npA-6[qOYB IAA(-/3S)?+tp-] a2 = trA= (1-fl5)-qpy-'tK-ip (A.29) (A.30) (A.31)
Sincethedeterminant is positive thesystem haveeither one or (A.27) must three roots.SincethetraceofA (and so thesumoftheroots)may positive be either or negative, we cannot ruleouttheunstable positive configuration
252
case on themore interesting We focus, however, ofall three rootspositive. saddle-point whereonlyone rootis positive.This givesrise to a typical but a direction ofinstability, positive rootcontributes structure: thesingle are assumedto choosean initial valueof e (and exchange-rate speculators a long-run towards henceof ;r) whichensuresthatthe modelconverges equilibrium. suggested byDixit(1980).He In order to solve(A.27) we use a technique are to lie on the showsthatif the solution pathsforthe threevariables mustsatisfy thefollowing equation: stablemanifold they
e(t)-e=
u1{kM(t)-kM} +u2{PS(t)-PS}
(A.32)
left characteristic vector where ofthe(normalized) ul and u2 are elements characteristic root.TheythereofA corresponding to theunstable positive theequation: foresatisfy
[ul u2 -1][-A+,Il=[0
0 0].
(A.33)
(A.33)maybe solvedforul rootof(A.28). Equation where a is thepositive and u2 in terms of a:

U P=
VAL L U2
YB
K+/
(A.34)
u2 -
(A.35)
which f=6 itcan be established is positive that/(8) Byevaluating (A.28)for that6>,i. Hence (A.34) and (A.35) showthatbothul and u2 are implies negative. an exogewhich under conditions Theseresults maybe used to establish its nous shockcauses the nominal exchangerateto overshoot long-run initial at their levels,(A.32) value. Since thevaluesofkMandps are fixed that: implies
e(
e=ul(k-kM)+U2(PS-fis).
(A.36)
the following wheree(0) is the value of the exchangerate immediately of that a resource boom and is lowered value of kM shock.The long-run by effect is dominant. Hence,as was asserted ps also fallsunlessthespending that is a presumption there in thetext, (in the implying e(O)-e is negative, Howeverit rateovershoots. case wheree<0) thatthe nominal exchange thecase. that thisis necessarily does notappearto be possibleto establish of two a to be reduced the system system (A.27) may Using (A.32),
differential equations in kM and ps:
AKoLUI) FkM1F,(yB [PS J- L?/J-Pe(l
P00L(
1 U2)1 [kMkml
-u2)J
(A37)
[PsPsJ
of (thedeterminant conditions are bothsatisfied The traceand determinant longHence convergence towards equals /np thecoefficient matrix &A/ft). thevalue is globally stable, with thesystem runequilibrium is guaranteed: Just as on thestablemanifold. to keepthesystem ofe changing continually notinevitable. with thesystem (A. 19),a cyclicalpathis possiblethough
References
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Neary, J.Peter:Short-run capital specificity and thepuretheory ofinternational trade.
Economy 86, 775-791, 1978.
85, 617-626, 1977. Economics 94,403-429, 1980. W. Max& Neary, Corden, J.Peter: Booming Neary,J. Peter:Wage stickiness, intersecsectorand de-industrialization toralfactor in a small reallocation and the case for open economy. Economic Journal 92, adjustment assistance. In J. Bhagwati 1982. (ed.), Import competitionand response, Dixit,Avinash:The balance of tradein a forthcoming, 1982. modelof temporary equilibrium J. Peter& Purvis, withra- Neary, DouglasD.: Real tioning.Review of Economic Studies 45, adjustment and exchange-rate dynamics. 393-404, 1978. NationalBureau of EconomicResearch Dixit,Avinash: A solution technique forraconference paper,1981. tionalexpectations modelswithapplica- Noman,Kamran& Jones,Ronald W.: A tionsto exchangerate and interest rate modelof tradeand unemployment. In J. determination. Mimeo,1980. Greenand J. Scheinkman (eds.), General Djajic,Slobodan: Intermediate equilibrium,growthand trade: Essays in inputs andinternational trade:An analysis of real and honour of Lionel McKenzie, pp. 297-322. effects ofan oil price monetary shock.MiAcademic Press.New York,1980. meo,1980. Purvis,Douglas D.: Wage responsiveness Dornbusch, and theinsulation Rudiger: Expectations and exproperties of a flexible change rate dynamics.Journalof Political exchange rate.In A. Lindbeck (ed.) (op. Economy 84, 1161-1176, 1976. cit.),pp. 225-245, 1979. Kouri,Pentti: and growth Profitability Charles in a Wilson, A.: Anticipated shocksand small openeconomy. InA. Lindbeck exchange rate dynamics.Journalof Politi(ed.),
Inflationand employment in open econocal Economy 87, 639-647, 1979.

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Sectoral Shocks in a Dependent Economy: Long-Run Adjustment and Short-Run Accommodation Author(s): J. Peter Neary and Douglas D.

Scand. J. ofEconomics 84 (2), 229-253,1982

Sectoral Shocksin a Dependent Economy: LongrunAdjustment and Short-run Accommodation

J. P. Neary and D. D. Purvis

II. Resource Allocation and Marshallian Adjustment in a Dependent Economy

Scand. J. of Economics 1982

234 J. P. Nearyand D. D. Purvis

equilibrium. Fig. 1. Factormarket

is positively sloped as depicted in Fig. 1, with points above the line

Sectoralshocksin a dependent economy 235

Fig. 2. Comparative statics and Marshallian dynamics.

J. P. Neary and D. D. Purvis

Sectoralshocksin a dependent economy 237

III. Marshallian with Adjustment

Scand. J. of Economics 1982

J. P. Neary and D. D. Purvlis

J. P. Neary and D. D. Purvis

Fig.4. Longrun equilibrium determination oftheinterest rateandthenominal exchange rate.

Sectoralshocksin a dependent economy 241

Fig. 5. Short-run equilibrium and exchange-rate dynamics following monetary deflation.

Sectoralshocksin a dependent economy 243

Fig. 6. Inappropriate response to a foreign priceshock.

There would be theexchange rateto E,, would be attainedinstantaneously.

Scand. J. of Economics 1982

J. P. Neary and D. D. Purvis

Fig. 7. Real adjustment to inappropriate monetary intervention.

Sectoral shocks in a dependenteconomy

Scand. J. of Economics 1982

J. P. Neary and D. D. Purvis

Fig. 8. Appropriate and inappropriate response to a resource boom.

Scand. J. of Economics 1982

The compensated elasticities ofdemand restriction ei obeythehomogeneity

world pricesby thenominal exchange ratee:

and the domestic prices of tradedgoods are relatedto their (A.2)

Real income, y, is defined as nominal incomedeflated by the consumer

Sectoral shocks in a dependenteconomy

J. P. Neary and D. D. Purvis

Thisis depicted by thepositively slopedKK curvein Fig. 1.

(A. 17) (A. 18)

A>0 The determinant of the coefficient matrixin (A.20) is given by pTVy-'

The money-market condition as follows: equilibrium (12) maybe written

J. P. Neary and D. D. Purvis

(A.33)maybe solvedforul rootof(A.28). Equation where a is thepositive and u2 in terms of a:

Sectoralshocksin a dependent economy 253

AKoLUI) FkM1F,(yB [PS J- L?/J-Pe(l

Neary, J.Peter:Short-run capital specificity and thepuretheory ofinternational trade.

Economy 86, 775-791, 1978.

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