Notes on Intertemporal Trade in Goods and Money

Abstract

Ever since Svensson and Razin (1983) pioneered intertemporal analysis in a cutting edge analysis of a microeconomic conundrum—the LaursenMetzler-Harberger problem of the terms of trade effect on spending—, intertemporal approaches to the current account have flourished. The state of the art is codified in Obstfeld and Rogoff (1995, 1996); the range of applications has widened to analyses involving risk, as in the most recent Obstfeld-Rogoff work or macroeconomic interdependence as in the ambitious paper of Corsetti and Pesenti (1998). The literature is in full swing. But it also suffers the difficulty that it quickly runs into diminishing returns—with many goods, assets and periods the range of outcomes quickly widens and models lose their leverage. The present paper takes the opposite tack of the literature in choosing heuristically to go backward toward the very simplest model and the most basic structure, namely trade in a single good and a common money. This simplification highlights intertemporal trade and focuses on Patinkin-Ricardo style monetary economics in the open economy. Imagine the simple question: there is one time increase in the home money supply, what happens to world real interest rate and the path of prices? More broadly, when does money have an effect on real interest rates and how does a fiscal policy disturbance affect price? As it turns out, in this very simple world of real interest rates, current and future price levels (even with functional forms that are rock