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

Olivier Cardi ()

Working Papers from HAL

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.

Keywords: Current account; Habit Formation; Temporary Shock; Terms of Trade. (search for similar items in EconPapers)
Date: 2011-02-22
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Related works:
Journal Article: Terms of Trade Shocks and the Non-Monotonic Adjustment of the Current Account (2011)
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