RDP 9508: Are Terms of Trade Rises Inflationary? Appendix 2: Derivation of Equation (7) in the Text

Equation (4) in the text, together with the definition χ=(1+σ+µ)⁻¹, implies that:

Substituting equations (2), (3) and (A2.1) into equation (1) in the text, and using the definition of the change in the real exchange rate, Δq=Δe+Δp−π^*, gives:

and therefore, after collecting like terms:

Dividing both sides by γχ and recognising that Δq=δΔTOT then leads straightforwardly to equation (7) in the text.