The Effects of Currency Substitution on the Response of the Current Account to Supply Shocks
24 Pages Posted: 15 Feb 2006
Date Written: January 19, 1988
Standard real models predict that a permanent increase in oil prices would result in a current account surplus. This is due to the fact that investment falls while saving remains unchanged. This paper shows that if currency substitution is introduced into the analysis, the same shock could cause a current account deficit. Furthermore, the higher the dependence of the economy on oil, the larger would be the deficit. The presence of foreign money makes it optimal for the public to decrease saving following the terms of trade deterioration. The fall in saving could be larger than the decline in investment.
JEL Classification: 4310, 4312
Suggested Citation: Suggested Citation