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The Response of the Current Account to Terms of Trade Shocks

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  • Paul Cashin
  • Christopher J. Kent

Abstract

Is the relationship between the current account balance and the terms of trade affected by the persistence of terms of trade shocks? In intertemporal models of the current account that incorporate a consumption-smoothing and an investment response to shocks, the effect of the terms of trade on external balances is predicted to be dependent on the duration of terms of trade shocks. Using a median-unbiased estimator, an unbiased model-selection rule, and terms of trade data for 128 countries over the period 1960-99 we identify two groups of countries-those that typically experience temporary terms of trade shocks and those that typically experience permanent terms of trade shocks. The results from panel-data regressions of the two groups of countries support the theoretical predictions of the intertemporal approach to the current account. We find that the greater (lesser) the persistence of the terms of trade shock, the more (less) the investment effect dominates the consumption-smoothing effect on saving, so that the current account balance moves in the opposite (same) direction as that of the shock.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/143.

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Length: 48
Date of creation: 01 Jul 2003
Date of revision:
Handle: RePEc:imf:imfwpa:03/143

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  1. Reuven Glick & Kenneth Rogoff, 1992. "Global versus country-specific productivity shocks and the current account," Working Papers in Applied Economic Theory 92-06, Federal Reserve Bank of San Francisco.
  2. Hussein, Khaled A. & de Mello, Luiz Jr., 1999. "International capital mobility in developing countries: theory and evidence," Journal of International Money and Finance, Elsevier, vol. 18(3), pages 367-381.
  3. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
  4. 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.
  5. Iscan, Talan B., 2000. "The terms of trade, productivity growth and the current account," Journal of Monetary Economics, Elsevier, vol. 45(3), pages 587-611, June.
  6. Haque, Nadeem U. & Montiel, Peter, 1991. "Capital mobility in developing countries: Some empirical tests," World Development, Elsevier, vol. 19(10), pages 1391-1398, October.
  7. Rudiger Dornbusch, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
  8. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks," IMF Working Papers 91/100, International Monetary Fund.
  9. DeJong, David N, et al, 1992. "Integration versus Trend Stationarity in Time Series," Econometrica, Econometric Society, vol. 60(2), pages 423-33, March.
  10. Basu, Parantap & McLeod, Darryl, 1991. "Terms of trade fluctuations and economic growth in developing economies," Journal of Development Economics, Elsevier, vol. 37(1-2), pages 89-110, November.
  11. Christopher Kent, 1997. "The Response of the Current Account to Terms of Trade Shocks: A Panel-data Study," RBA Research Discussion Papers rdp9705, Reserve Bank of Australia.
  12. International Monetary Fund, 1999. "Macroeconomic and Sectoral Effects of Terms-Of-Trade Shocks," IMF Working Papers 99/134, International Monetary Fund.
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Cited by:
  1. Diego N. Moccero, 2008. "The intertemporal approach to the current account: Evidence for Argentina," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 327-353, November.
  2. Graciela L Kaminsky, 2010. "Terms of Trade Shocks and Fiscal Cycles," RBA Annual Conference Volume, in: Renée Fry & Callum Jones & Christopher Kent (ed.), Inflation in an Era of Relative Price Shocks Reserve Bank of Australia.
  3. Nickel, Christiane & Vansteenkiste, Isabel, 2008. "Fiscal policies, the current account and Ricardian equivalence," Working Paper Series 0935, European Central Bank.
  4. 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.
  5. Narayan, Seema, 2013. "A structural VAR model of the Fiji Islands," Economic Modelling, Elsevier, vol. 31(C), pages 238-244.
  6. Gonzalo Hernández, 2011. "Terms of Trade and Output Fluctuations in Colombia," UMASS Amherst Economics Working Papers 2011-04, University of Massachusetts Amherst, Department of Economics.
  7. Diego Bastourre & Jorge Carrera & Javier Ibarlucia, 2008. "Commodity Prices in Argentina: What Moves the Wind?," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(51), pages 43-81, April - S.
  8. Piotr Misztal, 2010. "The Harberger-Laursen-Metzler Effect. Theory and Practice in Poland," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 13(38), pages 129-146, December.
  9. Paul Cashin & Samya Beidas-Strom, 2011. "Are Middle Eastern Current Account Imbalances Excessive?," IMF Working Papers 11/195, International Monetary Fund.

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