On the robustness of short run gains from trade reform / Lucy Rees and Rod Tyers Rees, Lucy

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Rees, Lucy
Free trade - Australia - Econometric models.; Exchange rates.; Australia.
The long run gains from reductions in distortionary tariffs are robustly positive in neoclassical economies. In the short run, however, depending on the prevailing exchange rate and tax regimes, a combination of producer price deflation and nominal wage stickiness can cause trade liberalisation to be contractionary. Because trade liberalisation, taken alone, reduces the home prices of foreign goods, there is a substitution away from home produced goods and a real depreciation. Under the explicit and de facto fixed exchange rate regimes adopted by many developing countries this necessitates a contractionary producer price deflation. Under the floating exchange rate regimes of the larger industrialised economies, if lost tariff revenue is replaced via a consumption tax increase, contractionary producer price deflation can also occur. This paper examines the implications of these and other policy combinations for the short run gains from trade reform using a comparative static numerical model of a generic, twosector, “almost small” open economy with asset markets and forward looking agents
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