Working Paper: NBER ID: w2078
Authors: Felipe Larrain; Jeffrey Sachs
Abstract: Recent macroeconomic models of developing countries have emphasized the possibility of contactionary devaluations, stressing that domestic aggregate demand is likely to be reduced by the devaluations while aggregate supply may respond only slowly to the change in relative prices brought about by the devaluation. These results have been obtained in static models. In this paper we add wage and export-sector dynamics to the models of contractionary devaluation, and show that the effects which produce contractionary devaluations in the short term can produce limit cycles in the long run. The economy never returns to long-run equilibrium following a devaluation, but rather moves with fixed periodicity through successive phases of boom and bust.
Keywords: Devaluation; Exports; Wages; Dynamic Adjustment
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Devaluation (F31) | Domestic Income (D31) |
| Devaluation (F31) | Aggregate Demand (E00) |
| Devaluation (F31) | Trade Balance (F14) |
| Devaluation (F31) | Economic Output (E23) |
| Devaluation (F31) | Wage Dynamics (J31) |
| Wage Dynamics (J31) | Economic Output (E23) |
| Economic State (Past) (N00) | Economic State (Current) (E66) |
| Devaluation (F31) | Instability in Export Sector (F14) |
| Hopf Bifurcation Cycle (E32) | Economic Oscillation (E32) |