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Terms-of-trade shocks and optimal investment: another look at the Laursen-Metzler effect

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  • Serven, Luis

Abstract

Conventional analyses of the effect of terms-of-trade shocks provide a misleading view of their impact on investment and the current account, because capital goods imports are excluded from the analytical framework. The author argues that such an exclusion is both arbitrary and unrealistic. The author reexamines the consequences of permanent and transitory changes in terms of trade in a rational-expectations model of a small open economy with intertemporally optimizing agents, and with trade in both consumption and capital goods. In this framework, the responses to a permanent terms of trade improvement in unambiguous: the long-run capital stock, and thus investment, must rise, and the current account must deteriorate -- exactly the opposite of the Laursen-Metzler effect. A transitory improvement in the terms of trade raises saving but has an uncertaineffect on investment. So, the impact on the current account is generally ambiguous and is shown to depend on three factors: the import contents on consumption and investment, the duration of the windfall, and the degree of intertemporal substitutability in both consumption and investment.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Money and Finance.

Volume (Year): 18 (1999)
Issue (Month): 3 ()
Pages: 337-365

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Handle: RePEc:eee:jimfin:v:18:y:1999:i:3:p:337-365

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Web page: http://www.elsevier.com/locate/inca/30443

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  1. Gavin, Michael, 1992. "Monetary policy, exchange rates, and investment in a Keynesian economy," Journal of International Money and Finance, Elsevier, vol. 11(2), pages 145-161, April.
  2. Reuven Glick & Kenneth Rogoff, 1993. "Global Versus Country-Specific Productivity Shocks and the Current Acocount," Boston University - Institute for Economic Development 31, Boston University, Institute for Economic Development.
  3. Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
  4. Serven, Luis, 1994. "Capital goods imports, the real exchange rate, and the current account," Policy Research Working Paper Series 1298, The World Bank.
  5. Spatafora, Nikola & Warner, Andrew, 1995. "Macroeconomic effects of terms-of-trade shocks : the case of oil-exporting countries," Policy Research Working Paper Series 1410, The World Bank.
  6. Hayashi, Fumio & Inoue, Tohru, 1991. "The Relation between Firm Growth and Q with Multiple Capital Goods: Theory and Evidence from Panel Data on Japanese Firms," Econometrica, Econometric Society, vol. 59(3), pages 731-53, May.
  7. Svensson, Lars E O, 1984. "Oil Prices, Welfare, and the Trade Balance," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 649-72, November.
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  9. Gavin, Michael, 1990. "Structural adjustment to a terms of trade disturbance : The role of relative prices," Journal of International Economics, Elsevier, vol. 28(3-4), pages 217-243, May.
  10. Turnovsky, S. & Sen, P., 1988. "Deterioration Of The Term Of Trade And Capital Eccumulation A Reexamination Of The Laursen-Metzler Effect," Discussion Papers in Economics at the University of Washington 88-08, Department of Economics at the University of Washington.
  11. Rudiger Dornbusch, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  12. Obstfeld, Maurice, 1996. "Intertemporal price speculation and the optimal current-account deficit: reply and clarification," Journal of International Money and Finance, Elsevier, vol. 15(1), pages 141-147, February.
  13. Obstfeld, Maurice, 1983. "Intertemporal price speculation and the optimal current-account deficit," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 135-145, August.
  14. Sadka, Joyce C. & Yi, Kei-Mu, 1996. "Consumer durables, permanent terms of trade shocks, and the recent US trade deficits," Journal of International Money and Finance, Elsevier, vol. 15(5), pages 797-811, October.
  15. 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.
  16. Cha, Baekin, 1993. "Dynamic effects of a terms-of-trade shock on a small open economy," Economics Letters, Elsevier, vol. 43(2), pages 205-209.
  17. Lahiri, Amartya, 1996. "Intertemporal price speculation and the optimal current-account deficit: a comment," Journal of International Money and Finance, Elsevier, vol. 15(1), pages 135-139, February.
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Cited by:
  1. Christiane Nickel & Isabel Vansteenkiste, 2008. "Fiscal policies, the current account and Ricardian equivalence," Working Paper Series 935, European Central Bank.
  2. Cardi, Olivier, 2007. "Another View Of The J-Curve," Macroeconomic Dynamics, Cambridge University Press, vol. 11(02), pages 153-174, April.
  3. Roberto Duncan, 2003. "The Harberger-Laursen-Metzler Effect Revisited: An Indirect-Utility-Function Approach," Working Papers Central Bank of Chile 250, Central Bank of Chile.
  4. CARDI, Oliver & BERTINELLI, Luisito, 2004. "A formal model of krugman’s intuition on the J-curve," CORE Discussion Papers 2004043, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Tarlok Singh, 2007. "Intertemporal Optimizing Models Of Trade And Current Account Balance: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 21(1), pages 25-64, 02.
  6. Olivier, CARDI, 2005. "The Zero-Root Property : Permanent vs Temporary Terms of Trade Shocks," Discussion Papers (ECON - Département des Sciences Economiques) 2005030, Université catholique de Louvain, Département des Sciences Economiques.
  7. Aleksander Aristovnik, 2006. "The Determinants & Excessiveness of Current Account Deficits in Eastern Europe & the Former Soviet Union," William Davidson Institute Working Papers Series wp827, William Davidson Institute at the University of Michigan.
  8. L. Sahely & R. Darius & O. Williams, 2001. "Terms of trade shocks and the current account in a unified currency area," Journal of International Development, John Wiley & Sons, Ltd., vol. 13(8), pages 1179-1188.

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