Trade policy under a binding foreign exchange constraint

Abstract

A three-sector model is developed to analyse trade policy in an economy facing a binding foreign exchange constraint. Increased imports of competitive goods may have contractionary effects in the short run, crowding out non-competitive imported intermediates. Devaluation, on the other hand, is expansive, relaxing the foreign exchange constraint and allowing for domestic output expansion. In a dynamic perspective policies associated with trade liberalization are likely to increase capital in the exportables sector, thereby creating more foreign exchange and lifting the economy to a level with higher capacity utilization.

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