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The rest of the world, foreign trade and the current account

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3.6 The rest of the world, foreign trade and the current account

The two economies are linked via trade and international capital flows.

(22)

We assume that households, firms and the government have CES preferences over domestic and foreign goods

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across goods used for consumption, and investment

. The share parameter s^Mcan be subject to a shock

and

are indexes of demand across the continuum of differentiated goods produced respectively in the two economies. We assume producer pricing. The stock of net foreign assets is thus given by

(24)

Where imports and exports are defined as

, and

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