THE EXCHANGE RATE, DIVERSIFICATION AND DISTRIBUTION IN A MODIFIED RICARDIAN MODEL WITH A CONTINUUM OF GOODS*

Abstract

Recent studies have revived interest in the relationship between the exchange rate and economic development. This paper develops a dynamic Ricardian model with a continuum of goods to consider the issue from a different perspective. In the short run, a devaluation can boost profits in spite of real wage rigidity. Moreover, the resulting diversification helps offset the consequences for the trade balance of higher employment and profitability. Over time, and in the presence of learning‐by‐accumulation, the initial boost to investment induced by a devaluation could enable a country to gain a permanent foothold in new sectors at a higher real wage.