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Deterioration Of The Term Of Trade And Capital Eccumulation A Reexamination Of The Laursen-Metzler Effect

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  • TURNOVSKY, S.
  • SEN, P.

Abstract

This paper analyzes the effects of both a permanent and a temporary deterioration In the terms of trade on a small open economy. The model, based on intertemporal optimization, emphasizes the labor-leisure choice and the role of capital accumulation There are two main conclusions to be drawn from the analysis. The first 1s that in all cases the transitional dynamics depends critically upon the long-run response of the capital stock to the deterioration m the terms of trade. This has been shown to consist of a substitution effect, which is negative, together with an income effect, which is positive. Secondly, since the steady state equilibrium depends upon the initla1 conditions of the economy, a temporary shock, by altering these initial conditions for some later date when the shock ceases, leads to a permanent effect on the economy. In the case where the substitution effect dominates, a deterioration in the terms of trade leads to a short-run reduction in investment and a short-run current account surplus, contrary to the Laursen-Metzler effect. However, when the long-run income effect dominates, the deterioration m the terms of trade leads to a short-run investment boom, accompanied by a short-term current account deficit. The Laursen-Metzler effect prevails, although it is driven by investment, rather than by savings behavior.
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Suggested Citation

  • Turnovsky, S. & Sen, P., 1988. "Deterioration Of The Term Of Trade And Capital Eccumulation A Reexamination Of The Laursen-Metzler Effect," Discussion Papers in Economics at the University of Washington 88-08, Department of Economics at the University of Washington.
  • Handle: RePEc:fth:washer:88-08
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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. Abel, Andrew B & Blanchard, Olivier J, 1983. "An Intertemporal Model of Saving and Investment," Econometrica, Econometric Society, vol. 51(3), pages 675-692, May.
    3. Kiminori Matsuyama, 1988. "Terms-of-Trade, Factor Intensities and the Current Account in a Life-Cycle Model," Review of Economic Studies, Oxford University Press, vol. 55(2), pages 247-262.
    4. Obstfeld, Maurice, 1983. "Intertemporal price speculation and the optimal current-account deficit," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 135-145, August.
    5. 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.
    6. Matsuyama, Kiminori, 1987. "Current account dynamics in a finite horizon model," Journal of International Economics, Elsevier, vol. 23(3-4), pages 299-313, November.
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    Citations

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    Cited by:

    1. Heng-Fu Zou, 1997. "Dynamic analysis in the Viner model of mercantilism," Journal of International Money and Finance, Elsevier, vol. 16(4), pages 637-651, August.
    2. Norman S. Fieleke, 1988. "International payments imbalances in heavily indebted developing countries," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 32, pages 58-102.
    3. Cardi, Olivier, 2007. "Another View Of The J-Curve," Macroeconomic Dynamics, Cambridge University Press, vol. 11(02), pages 153-174, April.
    4. 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.
    5. Chang, Wen-ya, 1999. "Government spending, endogenous labor, and capital accumulation," Journal of Economic Dynamics and Control, Elsevier, vol. 23(8), pages 1225-1242, August.
    6. Paul Cashin & C. John McDermott, 2003. "Intertemporal Substitution and Terms-of-Trade Shocks," Review of International Economics, Wiley Blackwell, vol. 11(4), pages 604-618, September.
    7. Huang, Kevin X.D. & Meng, Qinglai, 2007. "The Harberger-Laursen-Metzler effect under capital market imperfections," Journal of International Money and Finance, Elsevier, vol. 26(6), pages 1001-1015, October.
    8. Araujo, Juliana D. & Li, Bin Grace & Poplawski-Ribeiro, Marcos & Zanna, Luis-Felipe, 2016. "Current account norms in natural resource rich and capital scarce economies," Journal of Development Economics, Elsevier, vol. 120(C), pages 144-156.
    9. Arman Mansoorian, 1999. "On Cash in Advance Constraints for Open Economies," Working Papers 1999_02, York University, Department of Economics.
    10. Bye, Brita, 2000. "Environmental Tax Reform and Producer Foresight: An Intertemporal Computable General Equilibrium Analysis," Journal of Policy Modeling, Elsevier, vol. 22(6), pages 719-752, November.
    11. Eicher, Theo S. & Schubert, Stefan F. & Turnovsky, Stephen J., 2008. "Dynamic effects of terms of trade shocks: The impact on debt and growth," Journal of International Money and Finance, Elsevier, vol. 27(6), pages 876-896, October.
    12. Olivier Cardi, 2007. "The Zero-root Property: Permanent vs Temporary Terms-of-trade Shocks," Review of International Economics, Wiley Blackwell, vol. 15(4), pages 782-802, September.
    13. Arman Mansoorian & Mohammed Mohsin, 2002. "The Employment, Investment and Current Account Effects of Exchange Rate Policies in a Cash-in-Advance Economy," Working Papers 2002_04, York University, Department of Economics.
    14. Paul Cashin & C. John McDermott, 1998. "Terms of Trade Shocks and the Current Account," IMF Working Papers 98/177, International Monetary Fund.
    15. Javier Coto-Martinez & Huw Dixon, "undated". "Fiscal Policy in an Imperfectly Competitive Dynamic Small Open Economy," Discussion Papers 99/19, Department of Economics, University of York.
    16. Mansoorian, Arman, 1998. "Habits and durability in consumption, and the dynamics of the current account," Journal of International Economics, Elsevier, vol. 44(1), pages 69-82, February.
    17. Norman S. Fieleke, 1990. "Economic Adjustment In Heavily Indebted Developing Countries," Contemporary Economic Policy, Western Economic Association International, vol. 8(2), pages 18-35, April.

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