The Effects of Currency Substitution on the Response of the Current Account to Supply Shocks

24 Pages Posted: 15 Feb 2006

See all articles by Carlos A. Vegh

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Date Written: January 19, 1988

Abstract

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

Vegh, Carlos A., The Effects of Currency Substitution on the Response of the Current Account to Supply Shocks (January 19, 1988). IMF Working Paper No. 88/5, Available at SSRN: https://ssrn.com/abstract=884533

Carlos A. Vegh (Contact Author)

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

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University of Maryland - Department of Economics ( email )

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HOME PAGE: http://vegh.sscnet.ucla.edu

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