Equilibrium Exchange Rates and Supply‐Side Performance

Abstract

We develop a two‐country, optimising, sticky prices and sticky wages model of real exchange rate determination in the new open macroeconomics tradition to analyse the interaction between supply‐side behaviour, market structure and the real exchange rate. For a UK‐euro area calibration, supply‐side improvements to total factor productivity (TFP) or the degree of monopolistic competition in the goods and labour markets result in a depreciation of the real exchange rate. When TFP increases in the traded goods sector, a depreciation of the terms of trade offsets the appreciation of the relative price of non‐traded goods, contrasting with the Balassa‐Samuelson proposition.

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