SFB 303 Discussion Paper No. B - 450
Author: Pope, Robin, and Reinhard Selten
Title: Local Manufacturing Hurt by Depreciations in a Theoretical Model
Reflecting the Australian Experience
Abstract: The model is motivated by data showing that the Australian production
of
local manufactures is hurt by depreciations and invigorated by
appreciations. The
paper briefly presents such evidence and then proceeds to a theoretical
analysis. The
model aims at capturing short-to-medium run exchange rate effects in an
economy with goods and services aggregated into four commodities: Rural
goods
(agricultural, pastoral, forestry, fishing and mining products), imports,
local
manufactures and services. The latter three are directly consumed. Rural
goods
enter consumption only indirectly after processing by the manufacturing
sector.
Exports are exclusively rural goods.
The model has a Keynesian flavour. Production of local manufactures and
services
is not constrained by the availability of resources and of labour. Variable
inputs per
unit of output are assumed to be constant. There are also fixed inputs.
Variable
inputs are imports in the case of the import sector, rural goods and imports
in the
case of the local manufacturing sector, and labour in the case of the
services sector.
The prices of imports, local manufactures and services are set by constant
mark-up
factors on variable costs. This assumption is based on a picture of
imperfect
competition with constant elasticity of demand at the firm level.
The total production of rural goods is an exogenous parameter. The price of
rural
goods is determined in the export market. It falls with increasing exports.
The
economy is not assumed to be small in its export market. The domestic
consumption demand schedule is modelled as predetermined in the sense that
in
the time span under consideration the relationship between quantities
consumed
and nominal prices is not affected by the exchange rate. The nominal wage
rate is
assumed to be pre-determined in the same sense. No specific functional form
is
imposed on the consumption demand schedule: the analysis is based on general
assumptions, mainly non-inferiority and gross substitutability.
In view of gross substitutability, there is a competitive relationship
between imports
and local manufactures. A depreciation raises the price of imports and
ceteris
paribus such an increase raises the consumption of manufactures. However the
analysis shows that this enhancing influence of a depreciation on
manufacturing is
weaker than other causal channels which work in the opposite direction. An
increase in the price of imports raises variable costs and thereby the price
of local
manufactures. This leads to a decrease in the output of local manufactures.
In the course of the analysis, it is first shown that a uniquely determined
equilibrium
exists for every exchange rate above a lower bound. Then the effects of a
change in
the exchange rate are investigated. In most cases the results are
unambiguous. In
particular this is true for the output and the price of local manufactures.
Other
conclusions are that a depreciation increases exports and the amount of
services
provided. In some cases unequivocal results can be obtained only with the
help of
further assumptions. This concerns the domestic price of rural goods, the
balance of
trade in domestic prices and import penetration.
Keywords: exchange rate, manufacturing output, imported input costs, exportable
input
costs, raw materials exports, Australian economy
JEL-Classification-Number: F10, F14, F31, F40
Creation-Date: February 1999
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