NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Differences In Income Elasticities and Trends in Real Exchange Rates

Paul Krugman

NBER Working Paper No. 2761 (Also Reprint No. r1317)
Issued in November 1988
NBER Program(s):   ITI   IFM

One might expect that differences in income elasticities in trade and/or differences in growth rates among countries would give rise to strong secular trends in real exchange rates; for example, fast-growing countries might need steady depreciation to get the world to accept their growing exports. In fact, however, income elasticities are systematically related to growth rates by the "45-degree rule", under which fast-growing countries appear to face high income elasticities of demand for their exports, while having low income elasticities of import demand. The net effect of this relationship between elasticities and growth rates is that secular trends in real exchange rates are much smaller than one might otherwise have expected: relative PPP holds fairly well. This paper documents the existence of a "45-degree rule", and suggests an explanation in terms of increasing returns and product differentiation.

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Document Object Identifier (DOI): 10.3386/w2761

Published: European Economic Review, Vol. 33, No. 5, pp. 1031-1046, (May 1989).

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