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The Harberger-Laursen-Metzler Effect Revisited: An Indirect-Utility-Function Approach

  • Roberto Duncan

To study the effect of a terms-of-trade shock on the current account, Ostry and Reinhart (1992) and Cashin and McDermott (1998) estimate the intertemporal and intratemporal elasticities of substitution, for a set of countries, constructing importable and non-tradable consumption series. Unfortunately,these series are not available for most developing countries. This paper presents a dynamic stochastic framework, similar to Ostry and Reinhart’s, that maximizes a representative agent’s indirect utility function. The Euler conditions derived from the optimization problem do not depend on variables such as tradable and non-tradable consumption, avoiding the need for constructing them and adopting strong assumptions. Using GMM and Chilean quarterly data for the 1986-2002 period, I conclude that moderately low intertemporal and intratemporal substitution effects exist. The first estimated elasticity lies in the range of 0.46 to 0.56 and the latter is around 1.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 250.

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Date of creation: Dec 2003
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Handle: RePEc:chb:bcchwp:250
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  1. Raphael Bergoeing & Raimundo Soto, 2005. "Testing Real Business Cycle Models in a Emerging Economy," Central Banking, Analysis, and Economic Policies Book Series, in: Rómulo A. Chumacero & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (S (ed.), General Equilibrium Models for the Chilean Economy, edition 1, volume 9, chapter 7, pages 221-260 Central Bank of Chile.
  2. Sebastian Edwards, 1987. "Tariffs, Terms or Trade, and The Real Exchange Rate in and Intertemporal Optimizing Model of the Current Account," UCLA Economics Working Papers 429, UCLA Department of Economics.
  3. Serven, Luis, 1995. "Capital goods imports, the real exchange rate and the current account," Journal of International Economics, Elsevier, vol. 39(1-2), pages 79-101, August.
  4. Serven, Luis, 1995. "Terms-of-trade shocks and optimal investment : another look at the Laursen-Metzler effect," Policy Research Working Paper Series 1424, The World Bank.
  5. Torsten Persson & Lars E.O. Svensson, 1983. "Current Account Dynamics and the Terms of Trade: Harberger-Laursen-Metzler Two Generations Later," NBER Working Papers 1129, National Bureau of Economic Research, Inc.
  6. Turnovsky, S. & Sen, P., 1988. "Deterioration Of The Term Of Trade And Capital Eccumulation A Reexamination Of The Laursen-Metzler Effect," Working Papers 88-08, University of Washington, Department of Economics.
  7. 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.
  8. Kareken, John & Wallace, Neil, 1977. "Portfolio autarky: A welfare analysis," Journal of International Economics, Elsevier, vol. 7(1), pages 19-43, February.
  9. Masao Ogaki & Carmen M. Reinhart, 1998. "Measuring Intertemporal Substitution: The Role of Durable Goods," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1078-1098, October.
  10. Aaron Tornell & Philip Lane, 1994. "Are Windfalls a Curse? A Non-Representative Agent Model of the Current Account and Fiscal Policy," NBER Working Papers 4839, National Bureau of Economic Research, Inc.
  11. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-57, April.
  12. Jonathan D. Ostry, 1988. "The Balance of Trade, Terms of Trade, and Real Exchange Rate: An Intertemporal Optimizing Framework," IMF Staff Papers, Palgrave Macmillan, vol. 35(4), pages 541-573, December.
  13. Donald W.K. Andrews, 1988. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Cowles Foundation Discussion Papers 877R, Cowles Foundation for Research in Economics, Yale University, revised Jul 1989.
  14. 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.
  15. Matsuyama, Kiminori, 1988. "Terms-of-Trade, Factor Intensities and the Current Account in a Life-Cycle Model," Review of Economic Studies, Wiley Blackwell, vol. 55(2), pages 247-62, April.
  16. Sen, Partha & Turnovsky, Stephen J., 1989. "Deterioration of the terms of trade and capital accumulation: A re-examination of the Laursen-Metzler effect," Journal of International Economics, Elsevier, vol. 26(3-4), pages 227-250, May.
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