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Output Volatility and Openess to Trade: a Reassessment

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  • Eduardo A. Cavallo

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Abstract

Many economists believe that, while openness to trade increases average GDP growth rates, it also raises output volatility by exposing countries to terms-oftrade shocks. This view does not take into account that commercial trade might also reduce financially related volatility. Once this is taken into account, the relationship between exposure to trade and output volatility is still an open question. This paper presents new empirical evidence that suggests that the net effect of trade openness on output volatility is stabilizing. The results confirm that exposure to trade raises output volatility through the terms-of-trade channel as previously documented in the literature, but also show that this is counteracted by a quantitatively larger stabilizing effect. Additional evidence is presented showing that the latter effect comes (at least in part) through the financial channel. The methodology employed seeks to correct for the likely endogeneity of trade in this setting using gravity estimates as instrumental variables.

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Bibliographic Info

Article provided by LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION in its journal JOURNAL OF LACEA ECONOMIA.

Volume (Year): (2008)
Issue (Month): ()
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Handle: RePEc:col:000425:008594

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Keywords: openness to trade; output volatility; financial crises; gravity equation;

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References

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Cited by:
  1. Aizenman, Joshua & D. Chinn, Menzie & Ito, Hiro, 2009. "Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma," ADB Economics Working Paper Series 180, Asian Development Bank.
  2. Matteo Cacciatore, 2012. "International Trade and Macroeconomic Dynamics with Labor Market Frictions," 2012 Meeting Papers 875, Society for Economic Dynamics.
  3. Joshua Aizenman & Menzie D. Chinna & Hiro Ito, 2010. "The Financial Crisis, Rethinking of the Global Financial Architecture, and the Trilemma," Trade Working Papers 21873, East Asian Bureau of Economic Research.
  4. Aizenman, Joshua & Chinn, Menzie David & Ito, Hiro, 2009. "Assessing the Emerging Global Financial Architecture: Measuring the Trilemma's Configurations over Time," Santa Cruz Department of Economics, Working Paper Series qt840728sc, Department of Economics, UC Santa Cruz.
  5. Parinduri, Rasyad, 2012. "Growth volatility and trade: evidence from the 1967-1975 closure of the Suez Canal," MPRA Paper 39040, University Library of Munich, Germany.
  6. Spiliopoulos, Leonidas, 2010. "The determinants of macroeconomic volatility: A Bayesian model averaging approach," MPRA Paper 26832, University Library of Munich, Germany.
  7. Solomos, Dionysios & Papageorgiou, Theofanis & Koumparoulis, Dimitrios, 2012. "Financial Sector and Business Cycles Determinants in the EMU context: An Empirical Approach (1996-2011)," MPRA Paper 43858, University Library of Munich, Germany.
  8. César Calderón and Eduardo Levy Yeyati, 2007. "Zooming in: From Aggregate Volatility to Income Distribution," Business School Working Papers 2007-03, Universidad Torcuato Di Tella.
  9. EDWARDS, Jeffrey, 2009. "Trading Partner Volatility And The Ability For A Country To Cope: A Panel Gmm Model, 1970-2005," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 9(2).
  10. Calderon, Cesar & Loayza, Norman & Schmidt-Hebbel, Klaus, 2005. "Does openness imply greater exposure ?," Policy Research Working Paper Series 3733, The World Bank.
  11. Montalbano, Pierluigi, 2011. "Trade Openness and Developing Countries' Vulnerability: Concepts, Misconceptions, and Directions for Research," World Development, Elsevier, vol. 39(9), pages 1489-1502, September.

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