Current Account Effects of a Devaluation in an Optimizing Model with Capital Accumulation

This article explores the consequences of a devaluation in the context of a ‘real’, optimizing model of a small open economy. What provides for real effects of the devaluation is the existence of nominal wage stickiness during a contract period. We show that if this contract period is relatively short, the devaluation is bound to improve the current account on impact, whereas this will deteriorate in the case of a long contract period, and the more so the smaller are adjustment costs in investment. In addition, we study the consequences for the terms of trade and for the stocks of foreign assets and of capital.