Temporary Import Quota and the Current Account

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Abstract
This paper studies the effects of a temporary import quota on the real exchange rate and the current account of a small-open economy populated by utility-maximizing individuals. The optimal current-account response is determined by the interactions between two opposing forces: the intertemporal relative-price effect tends to improve the current account, while the wealth effect contributes to a deterioration. For a sufficiently low degree of intertemporal consumption substitution, the wealth effect is shown to dominate. The current account deteriorates in response to a temporary quota and improves only after the quota is lifted.
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