Working Paper: NBER ID: w0834
Authors: Maurice Obstfeld
Abstract: The paper uses an intertemporal perfect-foresight optimizing model to analyze the effect of transitory terms-of-trade shocks on a small open . economy's current-account and utility time profiles. An adverse terms-of-trade shift known to be temporary induces the economy to run down its stock of external assets in the period before the terms of trade revert to their initial level. Subsequently, the assets consumed during this period are reaccumulated. The current-account response is due only in part to a desire to smooth out the future consumption stream. In addition, households know that the real value of any debt incurred while the terms of trade are unfavorable will be reduced sharply when the terms of trade improve. This opportunity for intertemporal price speculation causes the time path of instantaneous utility to be discontinuous,
Keywords: current account; terms of trade; intertemporal optimization
JEL Codes: F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| temporary worsening of the terms of trade (F14) | current account deficit (F32) |
| temporary worsening of the terms of trade (F14) | reduction in consumption (D12) |
| current account deficit (F32) | consumption adjustments (E21) |
| current account deficit (F32) | current account surplus when terms of trade improve (F32) |
| anticipation of future terms of trade improvements (F17) | current consumption decisions (D15) |
| decline in the real value of debt (H63) | incentive to consume more (D11) |
| terms of trade improve (F14) | discontinuous change in instantaneous utility (D11) |