Income distribution, Dutch disease and real exchange rate movements

A theoretical intra-temporal model for an economy with three sectors (exportable, importable and non-tradable), two production factors (labour and capital) and Cobb Douglas (linear) technologies in the tradable (non-tradable) sectors is used to relate real exchange rate movements to factor productivities, factor endowments, terms of trade and debt shocks. We also determine whether exogenous shocks generate the Dutch disease or not. Up to now, theoretical models like this one have not taken into account the influence of the income distribution on the magnitude of the Dutch disease and real exchange rate response to exogenous shocks. However, our model does it. Furthermore, exogenous shocks do also impact on factor retributions and production levels. As a result, these shocks lead to distributional income effects. In our model, the real exchange rate response to exogenous shocks depends not only on preferences and technology structures but also on the initial economic structures of the countries under analysis. Such economic structures are measured through income distribution ratios and the ratio debt / GDP. Exogenous shocks change such economic structures through their distributional income effects. As a result, the real exchange rate response to exogenous shocks may be variable and different between countries.