Terms of Trade and Current Account Dynamics: A Methodological Critique.

Abstract

This paper suggests that the recent intertemporal studies concerning the implications of terms-of-trade deterioration on the current account of a small open economy may suffer from significant methodological deficiencies. The study demonstrates that, while the assumption of a small open economy represents a legitimate modeling simplification, the analysis of the impact of perturbation of the terms of trade on the current account of this small open economy is methodologically erroneous. In particular, the paper demonstrates that a given pattern of terms-of-trade deterioration may be associated with opposing evolutionary patterns of the current account of this small economy. Copyright 1994 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.