The Korean Economic Review
Exchange Rate Changes and Income Distribution
Yongkul WonYear 2008Vol. 24No. 1
This paper analyzes the impact of policy-induced exchange rate changes (devaluations) on the distribution of income between owners of different production factors in a dynamic specific factors model of the small open economy that produces traded and non-traded goods. In the model, workers are assumed to move freely between the sectors with a flexible wage rate while installed capital is sector-specific and new capital goods are constructed by combining non-traded inputs with imported machines. Various simulation results show that real return on capital in the nontradables sector always falls while that in the tradables sector invariably jumps up on impact following devaluation. Interestingly, real wage jumps up, stays unchanged, or falls on impact following devaluation depending mainly on relative factor intensity of the two sectors and the share of imported capital goods in production of capital goods. In the long run, of course, real factor incomes return to their new steady-state levels that are the same as their pre-devaluation levels.