Working Paper: NBER ID: w2629
Authors: Sebastian Edwards
Abstract: In this paper a general equilibrium intertemporal model with optimizing consumers and producers is developed to analyze how the temporary term's of trade disturbances affect the path of real exchange rates and the current account. Changes in the internal terms of trade (due to tariff changes) and to the external terms of trade are considered. The model is completely real, and considers a small open economy that produces and consumes three goods each period. It is shown that, without imposing rigidities or adjustment costs, interesting paths for the equilibrium real exchange rate can be generated. In particular "equilibrium overshooting" can be observed. Precise conditions under which a temporary import tariff will worsen the current account in period 1 are derived. The way in which temporary and permanent external terms of trade shocks will affect the current account are analyzed. Several ways in which the model can be extended are discussed The results obtained from this model have important implications for the design of balance of payments policy and for the analysis of real exchange rate misalignment and overvaluation.
Keywords: terms of trade; real exchange rate; current account; temporary tariffs
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 import tariffs (F19) | current account (F32) |
| temporary import tariffs (F19) | real exchange rate (F31) |
| temporary terms of trade disturbances (F16) | current account (F32) |
| temporary terms of trade disturbances (F16) | real exchange rate (F31) |
| real appreciation (D46) | current account (F32) |
| deterioration in terms of trade (F14) | current account (F32) |