Terms of Trade Shocks and the Current Account

40 Pages Posted: 15 Feb 2006

See all articles by Paul Anthony Cashin

Paul Anthony Cashin

International Monetary Fund (IMF)

C. John McDermott

Reserve Bank of New Zealand

Date Written: December 1998

Abstract

This paper examines the relationship between terms of trade shocks, private saving, and the current account position. The relationship between these variables is theoretically ambiguous: an adverse transitory terms of trade shock can either induce a deterioration or an improvement in the current account, depending on whether the resulting income effects are greater or less than the resulting substitution effects. The substitution effects involve both intertemporally substituting consumption and intratemporally substituting consumption between importables and nontradables. The relative strength of these substitution effects is estimated using data for five OECD countries during 1970/95; both are found to exert large and significant effects on the current account balance.

Keywords: Terms of trade, current account, intertemporal elasticity of substitution, intratemporal elasticity of substitution

JEL Classification: E21, F32, F41, 051, 052, 056

Suggested Citation

Cashin, Paul Anthony and McDermott, C. John, Terms of Trade Shocks and the Current Account (December 1998). IMF Working Paper No. 98/177, Available at SSRN: https://ssrn.com/abstract=883928

Paul Anthony Cashin (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

C. John McDermott

Reserve Bank of New Zealand ( email )

2 The Terrace
P.O. Box 2498
Wellington, 6011
New Zealand

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