Terms of Trade and Current Account Fluctuations - a Vector Autoregression Approach

This paper provides evidence on the Harberger-Laursen-Metzler (HLM) effect for the case of Peru. The HLM effect is the deterioration in the savings level of an economy due to a decline in their terms of trade for a given level of investment. This deterioration is caused by lower revenues which worsen the current account. We estimate VAR models that match up the following variables: terms of trade, export prices, import prices, current account, investment and saving. The results show that an unanticipated-permanent increase in the terms of trade (or export prices) improves the current account and saving rises. However, this effect disappears as investment grows faster than saving. On the other hand, an increase in the price of imports negatively affects the current account.