Traded Bond Denominations, Shock Persistence and Current Account Dynamics: Another Look at the Harberger–Laursen–Metzler Effect

Abstract

This paper presents an analytical framework to clarify the mechanism through which terms‐of‐trade shocks are transmitted to savings, investment and the current account. By imposing specific preferences to simplify their calculations in the presence of hysteresis, conventional investigations have incorrectly interpreted the macroeconomic effects of terms‐of‐trade disturbances. By concentrating on traded bond denominations and shock persistence, the present analysis reexamines the Harberger–Laursen–Metzler effect and offers new insight. The relevant results provide a rational explanation as to why external price changes lead to a variety of phases of different signs in the evolution of the current account dynamics.