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Terms-of-trade shocks and optimal investment : another look at the Laursen-Metzler effect, Volume 1
 
Author:Serven, Luis; Date Stored:2001/04/20
Document Date:1995/02/28Document Type:Policy Research Working Paper
SubTopics:Environmental Economics & Policies; International Terrorism & Counterterrorism; Economic Theory & Research; Payment Systems & Infrastructure; Free Trade; Fiscal & Monetary Policy; Financial IntermediationLanguage:English
Major Sector:(Historic)Economic PolicyReport Number:WPS1424
Sub Sectors:TradeCollection Title:Policy, Research working paper ; no. WPS 1424
Volume No:1  

Summary: Conventional analyses of the effect of terms-of-trade shocks provide a misleading view of their impact on investment and the current account, because capital goods imports are excluded from the analytical framework. The author argues that such an exclusion is both arbitrary and unrealistic. The author reexamines the consequences of permanent and transitory changes in terms of trade in a rational-expectations model of a small open economy with intertemporally optimizing agents, and with trade in both consumption and capital goods. In this framework, the responses to a permanent terms of trade improvement in unambiguous: the long-run capital stock, and thus investment, must rise, and the current account must deteriorate -- exactly the opposite of the Laursen-Metzler effect. A transitory improvement in the terms of trade raises saving but has an uncertain effect on investment. So, the impact on the current account is generally ambiguous and is shown to depend on three factors: the import contents on consumption and investment, the duration of the windfall, and the degree of intertemporal substitutability in both consumption and investment.

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