* Mr. Wattleworth, Senior Economist in the Research Department, is a graduate of the University of Illinois, Yale University, and the University of California, Berkeley. He wishes to thank his colleagues in the Fund for discussions that contributed substantially to the development of the paper.
The associated change in world value is the sum of the price and volume components. In the equations, lowercase letters indicate the natural logarithms of variables.
These real exchange rate changes are calculated bilaterally with the dollar and are specific to the commodity in question. This is a more narrowly defined concept than the conventionally defined real effective exchange rate (REER), which uses multilateral trade weights and currencies.
There is no doubt that Ridler and Yandle (1972) were thinking in terms of real exchange rate changes, but, given the low-inflation era in which they wrote, there must have seemed less need to couch the model explicitly in these terms.
Strictly speaking, this statement requires that the importer’s demand schedule, in terms of his own currency, remains unchanged; and that the exporter’s supply function is not affected by any cost change associated with the exchange rate change. For purposes of the analysis here, these are reasonable assumptions (International Monetary Fund (1972)).
Both the supply and demand equations could be altered to incorporate additional “shift factors,” such as income on the demand side, but such extensions are unnecessary for the purposes here. Similarly, the simple structure of the model abstracts from the elements that are not directly relevant to the first-round impact of the changes explored. For many primary products with long gestation lags (tree crops, mineral extraction), the first-round effects can easily take up to a decade. Various second-round effects—for example, through specification of “reaction functions”—could be hypothesized, but they are beyond the scope of this paper. See Chu and Morrison (1986) and Lebrun, Sapir, and Ulph (1985).
Devaluation in this formulation is a negative number; appreciation is a positive number (see footnote 10).
In other applications it might be useful to do a sensitivity analysis on the elasticity estimates if there is doubt about their reliability.
The baseline projections were part of a global projections exercise that produced a commodity price forecast over ten years that was consistent with a corresponding forecast for world prices of manufactures, a commonly used deflator, and with known assumptions regarding exchange rate changes, economic growth in industrial and developing countries, and other relevant variables affecting the supply and demand for commodities. The identities of the commodities and countries have been suppressed here, although all the data are actual.
Exchange rates are defined as units of national currency per dollar, and percentage changes are calculated as 100[(r1 - r2)/r2)], where r1 is the beginning exchange rate, and r2 is the final exchange rate. This method is equivalent to calculating percentage changes based on the value in the initial period and defining the exchange rate in terms of foreign currency units per unit of the nondollar national currency. This formulation was chosen so that appreciation of a currency is shown as a positive number, and depreciation, as a negative number. The year-on-year changes were computed as follows: for a 3 percent annual appreciation, r2 = (r1/1.03); for a 3 percent annual depreciation, r2 = (r1/0.97). The export share figures are taken from Table 2.
This is an example of the general result summarized in equation (10) and Table 3.
On the demand side, the baseline scenario assumes that the U.S. (country 17) dollar depreciates against other major currencies by 2.3 percent a year in real terms during the medium run; during other years, all major currencies remain unchanged. In terms of equation (3), for example, this implies that all Ki equal 9.5 percent in the medium run for all importers except the United States; correspondingly, the weighted-average outward shift in the world demand schedule (K) is equal to 6.4 percent by year 6. The weights are contained in Table 2. For suppliers, the baseline scenario assumes that country 4 depreciates by 1 percent a year against the U.S. dollar during all years, while all other exporters remain at par.