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We would like to thank Jahangir Aziz, Li Cui, Lamin Leigh, Leslie Lipschitz, and John Morgan for helpful comments.
Andrew Feltenstein, IMF Institute, International Monetary Fund, Washington DC 20431. Céline Rochon, Said Business School and Oriel College, University of Oxford, Park End Street, Oxford, OX1 1HP
It should be noted that this policy, to be discussed in Section IV, would be only a temporary measure that could eventually lead to further problems if additional measures were not taken.
Some countries undergo a persistent downward pressure on wages stemming from a lack of mobility between sectors.
The literature on applied macroeconomic general equilibrium models with a financial sector includes, among others, Labadie (1994), Diaz-Gimenez and others (1992), Altig, Carlstom and Lansing (1995), Chari, Christiano and Eichenbaum (1995), and Feltenstein (1992).
In practice, the coefficients for each sector’s value-added function, υaij, are derived from an actual input-output matrix based upon country data. In the observed input-output matrix, sectoral value-added is divided between wages of labor and returns to capital. We assume that the production of value-added in each sector is given by Cobb-Douglas functions with the shares of capital and labor determining the shares, αj, (1 − αj) of the value-added function in sector j. Accordingly, every time our computational algorithm changes relative factor prices, sector j cost minimizes its value-added function to determine inputs of capital and labor needed to produce one unit of output. Nominal value added per unit of output is then determined, which leads to the computation of output prices in Eq.#2.
These subsidies could potentially include interest rate subsidies.
We assume that all goods are traded and that the country is small so that the law of one price holds. Accordingly, expected profitability of investment is dependent only upon factor costs.
In order to simulate our model, we have taken ∊FDI= 1 in this admittedly ad hoc specification.
This section is largely taken from Feltenstein and Nsouli (2003). Appendix tables with actual values for estimated parameters may be found in that paper.
This outcome depends on the assumption of two-period perfect foresight, so that firms are essentially surprised by the rapid decline in returns to capital.
This should not be taken to indicate that a revaluation of China’s current fixed exchange rate should be recommended. Rather, this is a simulation that simply extends the recent small revaluations in the exchange rate. It could very well be claimed that a flexible rate, combined with financial sector reform, needs to be implemented for long-term stability.
Recall that there are single representative urban and rural consumers. Hence the workforce increase is equivalent to an endowment increase for each consumer.