Tariffs, Terms of Trade, and the Real Exchange Rate in an Intertemporal Optimizing Model of the Current Account

Sebastian Edwards

NBER Working Paper No. 2175
Issued in March 1987
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

In this paper a minimal general equilibrium intertemporal model, with optimizing consumers and producers, is developed to analyze the process of real exchange rate determination. The model is completely real, and considers a small open economy that produces and consumes three goods each period. The model is also used to analyze the way in which the current account responds to several shocks. The working of the model is illustrated for the case of two disturbances: the imposition of import tariffs, and external terms of trade shocks. In the case of import tariffs, a distinction is made between temporary, anticipated, and permanent changes. It is shown that, without imposing rigidities or adjustment costs, interesting paths for the equilibrium real exchange rate can be generated. In particular "overshooting" and movements in opposite directions in periods one and two can be observed. Precise conditions under which temporary import tariffs will improve the current account are derived. Finally, several ways in which the model can be extended to take into account other issues such as changes in the fiscal deficit, and financial deregulation are discussed in detail.

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Document Object Identifier (DOI): 10.3386/w2175


  • and the Current Account", Economica, Vol. 56, no. 223 (1989): 343-358.
  • (With J. Ostry) Published as "Anticipated Protectionist Policies, Real Exchange Rates, and the Current Account: The Case of Rigid Wages",Journal of International Money and Finance, Vol. 9, no. 2 (1990). Published as "Temporary Terms-to-Trade Disturbances, the Real Exchange Rate

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