This paper explores how an exchange rate devaluation affects the current account in a sticky price intertemporal optimizing model. The main issue we address is how the features of international pricing impact on the response of the current account. When prices are all set in producers currencies, a devaluation improves the current account as long as the conventional Marshall-Lerner elasticity condition is satisfied, which must be the case in our model. This is fundamentally an atemporal condition. But when prices are all set in consumer's currencies (pricing-to-market), the effect of devaluation on the current account depends upon the size of the intertemporal elasticity of substitution of consumption across time periods. The current account may rise or fall in this case. When pricing-to-market is partial, the effect of devaluation on the current account depends on the strength of the atemporal elasticity relative to the intertemporal elasticity.
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Paper provided by UBC Department of Economics in its series UBC Departmental Archives with number
99-08.
Find related papers by JEL classification: F30 - International Economics - - International Finance - - - General F31 - International Economics - - International Finance - - - Foreign Exchange F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
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