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Temporary Terms-of-Trade Disturbances, the Real Exchange Rate and the Current Account

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  • Edwards, Sebastian

Abstract

In this paper a general equilibrium intertemporal model with optimizing consumers and producers is developed to analyze how temporary terms-of-trade disturbances affect the path of real exchange rates and the current account. Changes in the internal terms of trade (arising from tariff changes) and to the external terms of trade are considered. The model is completely real, and considers a small open economy that produces and consumes three goods each period. It is shown that, without imposing rigidities or adjustment costs, interesting paths for the equilibrium real exchange rate can be generated. In particular, "equilibrium overshooting" can be observed. Precise conditions under which a temporary import tariff will worsen the current account in period 1 are derived. The way in which temporary and permanent external terms-of-trade shocks will affect the current account are analyzed. Several ways in which the model can be extended are discussed. The results obtained from this model have important implications for the design of balance of payments policy and for the analysis of real exchange rate misalignment and overvaluation. Copyright 1989 by The London School of Economics and Political Science.

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Bibliographic Info

Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 56 (1989)
Issue (Month): 223 (August)
Pages: 343-57

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Handle: RePEc:bla:econom:v:56:y:1989:i:223:p:343-57

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References

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  1. Torsten Persson & Lars E.O. Svensson, 1983. "Current Account Dynamics and the Terms of Trade: Harberger-Laursen-Metzler Two Generations Later," NBER Working Papers 1129, National Bureau of Economic Research, Inc.
  2. Obstfeld, Maurice, 1982. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," The Quarterly Journal of Economics, MIT Press, vol. 97(2), pages 251-70, May.
  3. Sebastian Edwards & Jonathan D. Ostry, 1987. "Anticipated Protectionist Policies, Real Exchange Rates and the Current Account," NBER Working Papers 2214, National Bureau of Economic Research, Inc.
  4. van Wijnbergen, Sweder, 1985. "Taxation of International Capital Flows, the Intertemporal Terms of Trade and the Real Price of Oil," Oxford Economic Papers, Oxford University Press, vol. 37(3), pages 382-90, September.
  5. Svensson, Lars E O & Razin, Assaf, 1983. "The Terms of Trade and the Current Account: The Harberger-Laursen-Metzler Effect," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 97-125, February.
  6. Razin, Assaf & Svensson, Lars E. O., 1983. "Trade taxes and the current account," Economics Letters, Elsevier, vol. 13(1), pages 55-57.
  7. Neary, J Peter, 1985. "International Factor Mobility, Minimum Wage Rates, and Factor-Price Equalization: A Synthesis," The Quarterly Journal of Economics, MIT Press, vol. 100(3), pages 551-70, August.
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Cited by:
  1. Paul Cashin & C. John McDermott, 1998. "Terms of Trade Shocks and the Current Account," IMF Working Papers 98/177, International Monetary Fund.
  2. Paul Cashin & Christopher J. Kent, 2003. "The Response of the Current Account to Terms of Trade Shocks," IMF Working Papers 03/143, International Monetary Fund.
  3. Narayan, Seema, 2013. "A structural VAR model of the Fiji Islands," Economic Modelling, Elsevier, vol. 31(C), pages 238-244.
  4. Chowdhury, Abdur R., 2003. "Do asymmetric terms of trade shocks affect private savings in a transition economy?," BOFIT Discussion Papers 3/2003, Bank of Finland, Institute for Economies in Transition.
  5. Cermeño, Rodolfo & Grier, Robin & Grier, Kevin, 2010. "Elections, exchange rates and reform in Latin America," Journal of Development Economics, Elsevier, vol. 92(2), pages 166-174, July.
  6. Kam Leong Szeto, 2002. "A dynamic computable general equilibrium (CGE) model of the New Zealand economy," Treasury Working Paper Series 02/07, New Zealand Treasury.
  7. Paul Cashin & C. John McDermott, 2003. "Intertemporal Substitution and Terms-of-Trade Shocks," Review of International Economics, Wiley Blackwell, vol. 11(4), pages 604-618, 09.
  8. Agenor, Pierre-Richard & Aizenman, Joshua, 2004. "Savings and the terms of trade under borrowing constraints," Journal of International Economics, Elsevier, vol. 63(2), pages 321-340, July.
  9. Michael Dueker, 1995. "Tariffs and asset market structure: some basic comparative dynamics," Working Papers 1995-009, Federal Reserve Bank of St. Louis.
  10. Aquino, Juan Carlos & Espino, Freddy, 2013. "Terms of Trade and Current Account Fluctuations: a Vector Autoregression Approach," Working Papers 2013-008, Banco Central de Reserva del Perú.

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