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Tariffs, Terms or Trade, and The Real Exchange Rate in and Intertemporal Optimizing Model of the Current Account

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  • Sebastian Edwards

    (UCLA)

Abstract

In this paper a minimal general equilibrium intertemporal model, with optimizing consumers and producers, is developed to analyze the process of real exchange rate determination. The model is completely real, and considers a small open economy that produces and consumes three goods each period. The model is also used to analyze the way in which the current account responds to several shocks. The working of the model is illustrated for the case of two disturbances: the imposition of import tariffs, and external terms of trade shocks. In the case of import tariffs, a distinction is made between temporary, anticipated, and permanent changes. It is shown that, without imposing rigidities or adjustment costs, interesting paths for the equilibrium real exchange rate can be generated. In particular "overshooting" and movements in opposite directions in periods one and two can be observed. Precise conditions under which temporary import tariffs will improve the current account are derived. Finally, several ways in which the model can be extended to take into account other issues such as changes in the fiscal deficit, and financial deregulation are discussed in detail.
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Suggested Citation

  • 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.
  • Handle: RePEc:cla:uclawp:429
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    File URL: http://www.econ.ucla.edu/workingpapers/wp429.pdf
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    References listed on IDEAS

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    1. Maurice Obstfeld, 1982. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," The Quarterly Journal of Economics, Oxford University Press, vol. 97(2), pages 251-270.
    2. Michael L. Mussa, 1986. "The Effects of Commercial, Fiscal, Monetary, and Exchange Rate Policies on the Real Exchange Rate," NBER Chapters,in: Economic Adjustment and Exchange Rates in Developing Countries, pages 43-88 National Bureau of Economic Research, Inc.
    3. J. Peter Neary, 1985. "International Factor Mobility, Minimum Wage Rates, and Factor-Price Equalization: A Synthesis," The Quarterly Journal of Economics, Oxford University Press, vol. 100(3), pages 551-570.
    4. 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.
    5. Aizenman, Joshua, 1985. "Tariff liberalization policy and financial restrictions," Journal of International Economics, Elsevier, vol. 19(3-4), pages 241-255, November.
    6. Kent P. Kimbrough, 1984. "Commercial Policy and Aggregate Employment Under Rational Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 99(3), pages 567-585.
    7. Razin, Assaf & Svensson, Lars E. O., 1983. "Trade taxes and the current account," Economics Letters, Elsevier, vol. 13(1), pages 55-57.
    8. Martin S. Feldstein, 1986. "The Budget Deficit and the Dollar," NBER Chapters,in: NBER Macroeconomics Annual 1986, Volume 1, pages 355-409 National Bureau of Economic Research, Inc.
    9. 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.
    10. Edwards, Sebastian & van Wijnbergen, Sweder, 1986. "The Welfare Effects of Trade and Capital Market Liberalization," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 27(1), pages 141-148, February.
    11. Sebastian Edwards & Liaquat Ahamed, 1986. "Economic Adjustment and Exchange Rates in Developing Countries," NBER Books, National Bureau of Economic Research, Inc, number edwa86-1, July.
    12. Dornbusch, Rudiger, 1974. "Tariffs and nontraded goods," Journal of International Economics, Elsevier, vol. 4(2), pages 177-185, May.
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    Cited by:

    1. Turnovsky, Stephen J., 1991. "Tariffs and sectoral adjustments in an open economy," Journal of Economic Dynamics and Control, Elsevier, vol. 15(1), pages 53-89.
    2. Roberto Duncan, 2003. "The Harberger-Laursen-Metzler Effect Revisited: An Indirect-Utility-Function Approach," Working Papers Central Bank of Chile 250, Central Bank of Chile.
    3. Sen, Partha & Turnovsky, Stephen J, 1989. "Tariffs, Capital Accumulation, and the Current Account in a Small Open Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 811-831, November.
    4. Kemme, David M. & Roy, Saktinil, 2006. "Real exchange rate misalignment: Prelude to crisis?," Economic Systems, Elsevier, vol. 30(3), pages 207-230, October.
    5. Edwards, Sebastian & Ostry, Jonathan D, 1992. "Terms of Trade Disturbances, Real Exchange Rates, and Welfare: The Role of Capital Controls and Labor Market Distortions," Oxford Economic Papers, Oxford University Press, vol. 44(1), pages 20-34, January.
    6. Harms, Philipp, 2001. "Deregulation and the current account," Discussion Papers, Series I 315, University of Konstanz, Department of Economics.
    7. Kam Leong Szeto & Paul Gardiner & Richard Gray & David Hargreaves, 2003. "A Comparison of the NZTM and FPS Models of the New Zealand Economy," Treasury Working Paper Series 03/25, New Zealand Treasury.
    8. Kam Leong Szeto, 2002. "A dynamic computable general equilibrium (CGE) model of the New Zealand economy," Treasury Working Paper Series 02/07, New Zealand Treasury.

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