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Terms of trade shocks and the non monotonic adjustment of the current account

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  • Olivier Cardi

    (ERMES - Equipe de recherche sur les marches, l'emploi et la simulation - UP2 - Université Panthéon-Assas - CNRS - Centre National de la Recherche Scientifique, X-DEP-ECO - Département d'Économie de l'École Polytechnique - X - École polytechnique - IP Paris - Institut Polytechnique de Paris)

Abstract

This paper investigates both the dynamic and steady-state effects of unanticipated permanent and temporary terms of trade shocks within a two-good small open economy with habit formation and capital adjustment costs. A permanent terms of trade worsening induces a deficit-surplus current account sequence if habits adjust faster than the physical capital. Following a temporary shock, the open country experiences first a larger short-run current account deficit triggered by a greater decline in savings, followed by a surplus driven by the drop in investment. Numerical results show that the hump-shaped adjustment of real consumption can lead to overall welfare gains if habit persistence is strong enough, the shock is short-lived, and trade openness is not too high.

Suggested Citation

  • Olivier Cardi, 2011. "Terms of trade shocks and the non monotonic adjustment of the current account," Working Papers hal-00567865, HAL.
    • Handle: RePEc:hal:wpaper:hal-00567865
    Note: View the original document on HAL open archive server: https://hal.science/hal-00567865
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    References listed on IDEAS

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    1. Stefan F. Schubert & Stephen J. Turnovsky, 2002. "The Dynamics of Temporary Policies in a Small Open Economy," Review of International Economics, Wiley Blackwell, vol. 10(4), pages 604-622, November.
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    5. Epstein, Larry G., 1987. "A simple dynamic general equilibrium model," Journal of Economic Theory, Elsevier, vol. 41(1), pages 68-95, February.
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