The Zero-Root Property : Permanent vs Temporary Terms of Trade Shocks

Abstract

This contribution shows that the persistence and the time of occurence of the shock matter in determining the long-run macroeconomic aggregates’ responses after permanent and transitory terms of trade shocks. Within a simple two-good small open economy model, we differentiate analyticaly between the (long-run) effects of four types of negative terms of trade disturbances of different degrees of persistence and occurence. We distinguish between permanent and transitory shocks, on the one hand, and between anticipated and unanticipated shocks, on the other hand, and finally we consider a permanent perturbation but viewed as temporary by agents. The application of a new analytical two-step procedure to the zero-root property case allows to obtain new conclusions not developed by previous studies : (i) a strong persistent terms of trade worsening may induce a decline in the long-run in the real expense and in the stock of net foreign assets greater than after a permanent disturbance, (ii) real expense may rise or fall in the long-run after an anticipated future permanent negative external shock depending on the time of occurence of the disturbance, and (iii) fails in expectation may induce large cut in real expense and translate into large losses in welfareSmall open economy; Terms of trade; Savings; Temporary shock