ECN 21003 - L4 International shocks

What are the three international shocks?

Terms of trade shock, world interest rate shock, tariff shock

What is terms of trade?

The relative prices of exports compared to imports

TT = Px/Pm

What is the terms of trade inter-temporal budget constraint?

How do terms of trade shocks act?

TT shocks act the same as output shocks in terms of permanent, temporary and anticipated. E.g. if TT1Q1 increases C1 and C2 will increase and the CA will deteriorate

What will happen if TT shocks are incorrectly or correctly anticipated (e.g. households expect TT2 to go back to TT)?

If households think TT2 will fall back to TT, they will suspend consumption as they see higher income now but none later

If households correctly predict TT2 will increase further than TT1 then they will spend more as incomes will increase in the future

How does higher and lower interest rates affect borrowers?

A higher rate means they pay more interest, so they are poorer. Consumption falls and saving rises. The income effect reinforces the substitution effect.

A lower rate means they pay less interest, so they are richer. Consumption increases and savings fall.

How does higher and lower interest rates affect lenders?

A higher rate means they earn more interest, so they are richer. Consumption rises and saving falls. The income effect opposes the substitution effect.

A lower rate means that they earn less interest, so they are poorer. Consumption falls and savings fall.

In what scenario do import tariffs affect the TB?

How future tariffs compare to current tariffs

What happens when future tariffs are more than current?

People spend more on imports before prices increase deteriorating the trade balance

What happens when current tariffs are more than future tariffs?

People postpone consumption waiting for prices to fall - TB improves

What happens when current and future tariffs are the same?

No change

What is the tariff inter-temporal budget constraint?