Nonexistence of Harberger-Laursen-Metzler Effect with Endogenous Time Preference in an Imperfect Capital Market

Deng‐Shan Wang ,Miao Jin

doi:10.1155/2015/836045

Abstract

This paper investigates the spending and current-account effects of a permanent terms-of-trade change in a dynamic small open economy facing an imperfect world capital market, where the households’ subjective discount rate is a function of savings. Under the assumption that the bond holdings are measured in terms of home goods, it is shown that when the discount rate is a decreasing function of savings, there does not necessarily exist a stable state; however, when the discount rate is an increasing function of savings, a saddle-path stable steady state comes into existence and the Harberger-Laursen-Metzler effect does not exist unambiguously; that is, an unanticipated permanent terms-of-trade deterioration leads to a cut in aggregate expenditure and a current-account surplus. The short-run effects obtained by the technique by Judd (1985, 1987) and Zou (1997) are consistent with the results from the long-run analysis and diagrammatic analysis.

Highlights

This paper aims at studying the Harberger-Laursen-Metzler effect that a terms-of-trade deterioration causes a reduction in national savings and a current-account deficit, in a dynamic small open economy
We investigate the long-run and short-run effects of termsof-trade deterioration on consumption and bond holdings and find that a terms-of-trade deterioration leads to a cut in consumption and a current-account surplus, which is contrary to the H-L-M effect
This paper has examined the terms-of-trade deterioration in a small open economy facing an imperfect world capital market

Summary

Introduction

This paper aims at studying the Harberger-Laursen-Metzler (hereafter H-L-M) effect that a terms-of-trade deterioration causes a reduction in national savings and a current-account deficit, in a dynamic small open economy. Angyridis and Mansoorian [21] study the H-L-M effect in a perfect capital market when the households have Marshallian time preference in Gootzeit et al [5], where the subjective discount rate is a decreasing function of current savings. They have supposed that the concave utility function U is negative to satisfy the inequality U󸀠󸀠U − (U󸀠)2 > 0, which guarantees their system to be saddle-point stable.

The Model

Dynamics and Long-Run Analysis

Short-Run Analysis

Conclusions