A THIRDGENERATION MODEL OF BOP CRISES: Interactions among balancesheets, real exchange rate and inve

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A THIRD-GENERATIONMODEL OF BOP
CRISESInteractions among balance-sheets, real
exchange rate and investment

• Based on Paul Krugman

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A simplifying assumption CAPITAL DOES NOT
CONSUME AND LABOR DOES NOT SAVE.
GDP
Aggregate demand
Real exchange rate
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Credit constraints
Simplifying assumption capital input enters
production with one-period lag.
Inputs markets are competitive
Capital markets arbitrage
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Credit-constrained investment
Actual (incentive-based) investment
Expected (aggregate) investment
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I-actual
45-DEGREE
H
L
I-expected
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If p is pegged, y becomes endogenous
That is, two equilibria, as in the Figure for the
case where p is not pegged
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One unit of capital good A price index
Capital input is an intermediate good
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First-order conditions
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A NEOCLASSICAL EQUILIBRIUM THE HORIZONTAL
LINE-SEGMENT
Given.
Note This explains the horizontal
segment-line in the figure.
is NOT varying with changes in
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Investment evaluated at current prices
The neoclassical segment
Recall that p is negatively related to
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H
L
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MITIGATING EFFECT CAPITAL INVESTMENT ENTERS
PRODUCTION WITH NO LAGS
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Note the transfer problem works through both
supply and demand changes
Thus, dW/dI gets smaller as the investment-lag is
reinstated (the previous case).
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Pegged real exchange rate
y becomes demand-determined!
A loop W depends on y, which in turn depend on
I I depends on W through supply of credit.