Traded Goods, Competitiveness and Aggregate Fluctuations in the United Kingdom

Along with rational expectations, the 1970s have bequeathed macroeconomics with the importance of the supply side. Models that emphasize relative prices are increasingly finding their way into the mainstream of open economy macroeconomics. One important class of these models comprises the 2-sector models that emphasize the distinction between internationally traded and nontraded goods. Until now, the literature using these models has been mainly theoretical. Using aggregate time series for the UK, a variant of these models is tested empirically. The econometric estimates suggest that, at a general level, the model is quite successful in accounting for the UK business cycle. At a deeper level, however, the main problem is an implausibly low estimate of one crucial parameter - the share of tradables in gross domestic product. The model suggests that government expenditure can be used to affect unemployment systematically, but it is at the expense of fluctuations in competitiveness.