Growth, Expansion of Markets, and Income Elasticities in World Trade
IMF Working Papers, January 1, 2005
Source details
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- Growth, Expansion of Markets, and Income Elasticities in World Trade
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Bibliographic details
- Authors: Yi Wu
- Published: January 1, 2005
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451860306.001
Summary and central finding
- The Houthakker-Magee effect implies that a country facing unfavorable income elasticities in trade must either grow at a slower rate than its trading partners or experience a trend worsening of its current account and/or depreciation of its real exchange rate.
- Krugman (1989) documented a “45-degree rule” under which relative income elasticities are systematically related to relative growth rates.
- This paper develops and tests an intertemporal current account model in which Krugman’s original 45-degree rule is a special case.
- The main result suggests that secular trends in current accounts and/or real exchange rates are much smaller than one would have projected based on conventional income elasticities.
Model and theoretical framework
- Framework: An intertemporal current account model that nests Krugman’s “45-degree rule” as a special case.
- The analysis links relative income elasticities to relative growth rates and to the dynamics of current accounts and real exchange rates.
- Theoretical implication: Unfavorable income elasticities do not mechanically translate into large secular deteriorations of current accounts or large depreciations of real exchange rates once intertemporal considerations are accounted for.
Empirical testing and results
- The paper develops and tests the model empirically (details of samples and estimation not provided in the page overview).
- Empirical conclusion: Observed secular trends in current accounts and/or real exchange rates are much smaller than projections based on conventional income elasticities would indicate.
Subject coverage and keywords
- Subject: Consumption, Exports, Imports, Personal income, Price elasticity
- Keywords: low income, price index, WP
Policy implications and interpretation
- Policymakers should be cautious in inferring large persistent current account deteriorations or large real exchange rate depreciations solely from cross-sectional or conventional estimates of income elasticities.
- Intertemporal adjustment and growth differentials across trading partners can mitigate the projected effect of income elasticities on trade balances and real exchange rates.