Working Paper: NBER ID: w2110
Authors: Sebastian Edwards
Abstract: This paper uses three models of a small open economy to analyze the effects of terms of trade and exchange rate changes (i.e. devaluations) on labor market adjustment. First, a three goods (exportables, importables, non-tradables), four factors model is developed and used to investigate how an exogenous worsening of the intern.ationa1 terms of trade affect labor allocation and wages. Second, a more traditional three goods, two factors model is used, and its results are compared to those of the first case. The analysis is carried out under alternative assumptions regarding wage flexibility: full flexibility, economy-wide (real) wage rigidity, and sector specific real wage rigidity. Finally, a three final goods model with imported intermediate inputs is used to investigate the effects of devaluations on aggregate and sectoral employment. Here the conditions under which a devaluation will be contractionary (i.e. will result in a reduction of employment) are determined.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Terms of trade shocks (F14) | Labor market adjustments (J48) |
| Full wage flexibility (J31) | Increased wages in sectors benefiting from improved terms of trade (J39) |
| Wage rigidity (J31) | Reduced employment levels after nominal devaluation (F66) |
| Terms of trade improvements (F14) | Higher wages in export sectors (F16) |
| Terms of trade improvements (F14) | Negative impact on import sectors under wage rigidity (F66) |