Agriculture Reference
In-Depth Information
In the capital market (upper) part of the diagram in Figure A9.3, this
means the GDP-drven tendency of the
NFI
curve to shft left s larger.
Ths offsets the tendency for nvestment to rse (whch s the same as n
the fixed exchange rate case since the same change in return to installed
captal s expected). So the net rghtward shft n the
NFI
curve is smaller,
as s the rse n the home nterest rate; and hence there s a fall n real
investment spending. All these results are verified numerically in column
3 of Table A9.8. The key result in the floating rate case is that, although
the real production wage still rises, it does so by less than would have
occurred had employment been fixed. The gain in allocative efficiency
would have yelded a larger real producton wage gan. Because ths gan
is restrained by nominal wage stickiness, there is a rise in employment
and an unambiguous increase in GDP in the short run. Therefore, if it can
be managed, exchange rate flexibility is superior to a fixed rate regime
durng a trade reform and where captal controls are tght.
If the capital controls are removed, the corresponding liberalisation
shock is as depicted in Figure A9.4. Here, reduced protection also yields
a gain in allocative efficiency and hence there is a rise in GDP, reinforcing
the rightward shift in the net imports curve. In this case, however, the
absence of capital controls allows investment to flow in, responding to
the ncrease n the expected long-run return on nstalled captal. The
increased inflow on the capital account relaxes the balance of payments
constrant n the lower dagram and allows a substantal ncrease n net
mports. The net effect on the real exchange rate depends on whether
this effect, in raising the net supply of foreign goods, is larger or smaller
than the ncrease n net demand for them due to the tarff reducton and
the rise in domestic income. In the case of China, the rise in net demand
is dominant and the real exchange rate still depreciates, albeit to a lesser
extent than n the presence of captal controls (compare columns 2 and 4
of Table A9.8). Figure A9.4 is drawn correspondingly.
With a real depreciation on the left-hand side of Equation 3, the result is
either a nominal depreciation or a domestic deflation, or both, depending
on the target of monetary policy. If the nominal exchange rate is fixed, the
domestc (
P
Y
) deflation is larger. With sticky nominal wages, this causes a
larger rse n the real producton wage and hence a smaller expanson n
