The Response of the Current Account to Terms of Trade Shocks: Persistence Matters

July 1, 2003

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Paul Cashin, and Christopher J. Kent The Response of the Current Account to Terms of Trade Shocks: Persistence Matters, (USA: International Monetary Fund, 2003) accessed September 18, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Is the relationship between the current account balance and the terms of trade affected by the persistence of terms of trade shocks? In intertemporal models of the current account that incorporate a consumption-smoothing and an investment response to shocks, the effect of the terms of trade on external balances is predicted to be dependent on the duration of terms of trade shocks. Using a median-unbiased estimator, an unbiased model-selection rule, and terms of trade data for 128 countries over the period 1960-99 we identify two groups of countries-those that typically experience temporary terms of trade shocks and those that typically experience permanent terms of trade shocks. The results from panel-data regressions of the two groups of countries support the theoretical predictions of the intertemporal approach to the current account. We find that the greater (lesser) the persistence of the terms of trade shock, the more (less) the investment effect dominates the consumption-smoothing effect on saving, so that the current account balance moves in the opposite (same) direction as that of the shock.

Subject: Balance of payments, Consumption distribution, Current account, Current account balance, Exchange rate arrangements, Foreign exchange, International trade, National accounts, Terms of trade

Keywords: Africa, Confidence interval, Consumption distribution, Current account, Current account balance, Current account response, Current account to a terms of trade shock, Exchange rate arrangements, Investment effect, Least squares, Least squares estimate, Permanent terms of trade shock, Response of the current account to terms of trade shock, Shock persistence, Terms of trade, Terms of trade change, Terms of trade result, Terms of trade shock, TOT shock, WP

Publication Details

Pages:

48
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/143
Stock No:

WPIEA1432003
ISBN:

9781451856361
ISSN:

1018-5941

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