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

  • Edwards, Sebastian

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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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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  1. Persson, Torsten & Svensson, Lars E O, 1985. "Current Account Dynamics and the Terms of Trade: Harberger-Laursen-Metzler Two Generations Later," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 43-65, February.
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. Maurice Obstfeld, 1981. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," NBER Working Papers 0686, National Bureau of Economic Research, Inc.
  7. Razin, Assaf & Svensson, Lars E. O., 1983. "Trade taxes and the current account," Economics Letters, Elsevier, vol. 13(1), pages 55-57.
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