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Andrew Feltenstein is professor of economics at Virginia Polytechnic Institute and State University, while Jiming Ha is an economist in the Fiscal Affairs Department of the International Monetary Fund. The paper was written while Andrew Feltenstein was visiting the Fiscal Affairs Department. The authors would like to thank Mario Blejer, Ke-young Chu, and Vito Tanzi for a number of helpful comments. The views expressed are those of the authors and do not necessarily reflect the opinions of the IMF.
Capital is sector specific and hence the price of capital will differ across sectors. We have not indicated the differing prices for different types of capital in order to avoid unreadable subscripts.
In order to incorporate a distinction between public and private bonds it would be necessary to have a notion of risk. Otherwise our model would always generate corner solutions in which one or the other, but never both, of the two assets were held in the consumer’s portfolio.
This approach is motivated by the Harris and Todaro (1970) model of rural-urban migration, in which movement to the city depends upon relative urban/rural wage rates, as well as the probability of finding work in the city. Feltenstein (1992) estimates such a migration model for Mexico.
Thus, for example, the government might desire a stock of foreign reserves equal to three months of exports. We let this level be a policy parameter and do not derive it from optimizing behavior.
This may thus be interpreted as a “leaning against the wind” exchange rate policy in which the government changes the rate to compensate for movements in reserves. The speed of adjustment is a policy parameter set by the government.
Directly estimating #x03B2; together with Δ’s may lead to biased results because of the multicolinearity between private and public capitals.
We do not wish to claim that we are way replicating the actual economy, so these parameters should be viewed as having only illustrative value.
The percentage increase is, of course, arbitrary and serves only for illustrative purposes.