Nominal growth in a small open economy
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This paper develops a flexible price, two-sector nominal growth model, to study the nominal effect of capital accumulation (nominal and real convergence). The authors adopt a classical model of a small open economy with traded and non-traded goods, and enrich its structure with gradual investment and a preference for real money holdings. The modelling framework gives the following results. (1) The level of the exchange rate has a medium-run impact on nominal and real variables but no long-run effect on real variables. (2) Along the real equilibrium path of the economy, capital accumulation implies an increase of the price of non-tradables (real appreciation). (3) By comparing the nominal and the real equilibrium paths, the authors introduce a notion of misalignment. (4) The same comparison makes it possible to analyse the effect of misalignment on nominal and real variables.
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