Intertemporal price speculation and the optimal current-account deficit
The paper studies the effects of terms-of-trade fluctuations in an infinite-horizon optimizing model of a small open economy. While the current-account response to a transitory terms-of-trade shock is in part explicable by intertemporal smoothing, an important additional factor is the effect of anticipated future terms-of-trade shifts on the real value of the external debt in terms of the home consumption basket. When foreign borrowing is indexed to the import good, a temporary worsening of the terms of trade creates the expectation of a decline in the real value of external debt. This fall in the relevant real interest rate leads households to increase consumption while export prices are low and to decrease consumption sharply once the terms of trade recover. If an adverse price shock is of sufficiently brief duration, instantaneous utility will rise initially.
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- Dornbusch, Rudiger, 1982. "Consumption opportunities and the real value of the external debt," Journal of Development Economics, Elsevier, vol. 10(1), pages 93-101, February.
- Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
- Dornbusch, Rudiger, 1983.
"Real Interest Rates, Home Goods, and Optimal External Borrowing,"
Journal of Political Economy,
University of Chicago Press, vol. 91(1), pages 141-153, February.
- Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
- Obstfeld, Maurice, 1980. "Intermediate imports, the terms of trade, and the dynamics of the exchange rate and current account," Journal of International Economics, Elsevier, vol. 10(4), pages 461-480, November.
- Maurice Obstfeld, 1980. "Intermediate Imports, the Terms of Trade, and the Dynamics of the Exchange Rate and Current Account," NBER Working Papers 0540, National Bureau of Economic Research, Inc.
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