Exchange rate shocks and the current account under monopolistic competition: An intertemporal optimization model

This paper examines the current-account effect of a devaluation in a Chamberlinian model where both saving and investment are based on intertemporal optimization. It shows that devaluation tends to deteriorate the current account along the time horizon, leading to a reduction of the stock of foreign assets permanently. In contrast to recent work, these real effects do not rely on short-run disequilibrium in the goods or labor market. Besides, a temporary devaluation may generate hysteresis effects on both micro- and macro-economic aspects of a small economy.