Working Paper: CEPR ID: DP2644
Authors: Konstantine Gatsios
Abstract: This Paper constructs a general equilibrium trade model of a small open economy producing an exported good, an imported good and a non-traded good by using two or more factors of production, one of which, namely capital, is imperfectly internationally mobile. Within this framework, it is shown that an exogenous capital inflow may lead to a depreciation of the real exchange rate, and to an increase in both the nominal and the real rate of return to capital. For these paradoxical results to occur it is necessary that the non-traded good is capital intensive.
Keywords: capital mobility; nominal and real rate of return to capital; real exchange rate
JEL Codes: F10; F20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exogenous capital inflow (F21) | Depreciation of the real exchange rate (F31) |
| Exogenous capital inflow (F21) | Increase in nominal rate of return to capital (E25) |
| Exogenous capital inflow (F21) | Increase in real rate of return to capital (E25) |
| Substitution effect in production (for capital-intensive nontraded goods) (D24) | Depreciation of the real exchange rate (F31) |
| Income effect in consumption (D12) | Depreciation of the real exchange rate (F31) |
| Capital inflow (absence of capital taxes) (F21) | Reduction in nominal rate of return to capital (E25) |
| Capital inflow (presence of capital taxes) (F21) | Increase in nominal rate of return to capital (if nontraded good is capital intensive) (F16) |
| Substitution effect in production, Income effect in consumption (D11) | Real rate of return to capital (D33) |