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We are grateful to Georges de Menil, Jeffrey Frankel, Robert Gordon, Richard Marston, Jorge Roídos, Linda Tesar, and seminar participants at the International Seminar on Macroeconomics, Brown University, Federal Reserve Board, IGIER, the NBER Summer Institute, and New York University for valuable discussions and comments. We are also grateful to Reuven Glick, Xavier Sala-i-Martin, and Linda Tesar for helping us with the data. This paper will be published in the European Economic Review.
For specificity, we will throughout the paper use the expression “relative price of nontradables”. Nevertheless, it is useful to bear in mind that an increase in this relative price corresponds to a real appreciation.
Kravis and Lipsey (1983) and Bhagwati (1984) presents an alternative supply-side view based on factor endowment differentials. The fairly narrow distribution of relative factor endowments across OECD economies renders this approach more relevant for discussion of relative price movements between LDCs and DCs than for the datasets underlying our analysis.
The assumption rules out the use of the current account to smooth consumption, and thus ignores the different response of the economy to transitory and permanent shocks. For an intertemporal analysis of the current account and its empirical implications in a similar framework to the one of this paper see Stockman and Tesar (1990) and Glick and Rogoff (1993).
See Bergstrand (1991). Relative demands may also be shifted by changes in the preference parameter ɸ [De Gregorio, Giovannini and Krueger (1993)]. In this case, increased demand for nontradables is again reflected by an increase in both the relative price and relative production of nontradable goods.
The last option has been followed by Rogoff (1992) to find an explicit solution for changes in the real exchange rate in a model without capital mobility across sectors. See also Froot and Rogoff (1991b) for additional discussion.
Australia (AUS), Belgium (BEL), Canada (CAN), Denmark (DNK), Finland (FIN), France (FRA), Germany (GER), Italy (ITA), Japan (JPN), the Netherlands (NLD), Norway (NOR), Sweden (SWE), the United Kingdom (GBR) and the United States (USA).
(1) Agriculture, (2) mining, (3) food, beverages, tobacco, (4) textiles, (5) wood and wood products, (6) paper, printing, publishing, (7) chemicals, (8) non-metallic mineral products, (9) basic metal products, (10) machinery, equipment, (11) other manufactured products, (12) electricity, gas, water, (13) construction, (14) wholesale and retail trade, (15) restaurants, hotels, (16) transport, storage, communication, (17) finance, insurance, (18) real estate, (19) community, social and personal services and (20) government services.
As far as possible, missing observations were matched to avoid distortions.
Our classification coincides with that used by Stockman and Tesar (1991).
Since the computations are sensitive to changes in the factor shares across time, we use the average factor share during 1970—85 for each sector and country.
This result is (empirically) not driven by the correction αN/αT, it holds when both shares are assumed to be the same.
For related empirical evidence on determinants of the real exchange rate see Hsieh (1982), Marston (1987), Froot and Rogoff (1991a, b), Bergstrand (1991), De Gregorio, Giovannini and Krueger (1993), and Wolf (1993).
To test for robustness, all regression reported in this section and the evidence presented in the previous section were performed with two alternative classifications. The first one excluded electricity, gas and water, production of government services, and other services from the nontradable goods sector, and included transportation, storage and communication services as nontradable goods. The second alternative classification looked at a narrower set of sectors, by including only manufacturing as tradable goods; and wholesale and retail trade, restaurants, hotels, transport, storage, communication, finance, insurance, real estate, and community, social and personal services as nontradables. Overall, the results were robust to this changes of classification, indicating that our result are not stemming from some specific sector misclassified.
To capture potential country specific effects, the regressions were also estimated with country specific intercepts, and the results did not change significantly.
Since we are interested in trend movements, we exclude the temporary effects from changes in inflation.