Intermediate Inputs, External Rebalancing and Relative Price Adjustment

50 Pages Posted: 26 Jul 2014

See all articles by Rudolfs Bems

Rudolfs Bems

International Monetary Fund (IMF); European Central Bank (ECB)

Date Written: July 2, 2014

Abstract

This paper proposes a methodology for tracing out the effect of intermediate inputs, including ‘processing trade’, on the link between external rebalancing and relative price adjustment. We find that neglect of inputs distorts parameterization of the traditional multi-sector macro model. Distortions affect the link between external rebalancing and relative price through several opposing channels. (1) Mismeasured imported inputs exaggerate economic openness and understate the price response to rebalancing. (2) Mismeasured domestic inputs increase cross-sectoral asymmetry in openness, leading to an overstated price response. (3) Mismeasured price elasticities tend to overstate the price response. (4) Distortions in model parameters interact to generate a sizable further understatement of the price response. Quantitative results show that the identified channels can each be significant in economic terms.

Keywords: Real exchange rate; external sector adjustment; intermediate inputs; transfer problem

JEL Classification: F32, F41

Suggested Citation

Bems, Rudolfs, Intermediate Inputs, External Rebalancing and Relative Price Adjustment (July 2, 2014). ECB Working Paper No. 1699, Available at SSRN: https://ssrn.com/abstract=2461714

Rudolfs Bems (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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