Terms of Trade Shocks and the Non-Monotonic Adjustment of the Current Account

Olivier Cardi

Annals of Economics and Statistics, 2011, issue 103-104, 195-221

Abstract: This paper investigates both the dynamic and steady-state effects of anticipated 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 a larger short-run current account deficit triggered by a greater decline in savings, followed by a surplus driven by a 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.

Date: 2011
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Working Paper: Terms of trade shocks and the non monotonic adjustment of the current account (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:adr:anecst:y:2011:i:103-104:p:195-221

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