Terms of Trade Risk

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Terms of Trade Risk

Author Info

Benjamin Dennis () (Department of Economics, University of the Pacific)
Talan Iscan () (Department of Economics, Dalhousie University)

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Abstract

This paper analyzes income and consumption risk resulting from fluctuations in the terms-of-trade in a small open economy when factors can be reallocated after incurring a fixed cost. This fixed cost of relocation across sectors introduces partial labor mobility and sector-specific uncertainty. We find that these risks can be significant, even with small adjustment costs and moderate degrees of terms-of-trade volatility. When sector-specific risks are uninsurable, factor immobility leads to considerable income disparity and welfare losses on the order of up to a one percent permanent reduction in consumption. Of the total welfare costs faced by an economy with fixed costs of reallocation, the magnitude of these risks alone is comparable to the aggregate welfare costs that a frictionless economy would experience as a result of terms-of-trade fluctuations. Thus, the welfare costs of terms-of-trade fluctuations for an economy with fixed relocation costs are considerably greater than that of a frictionless economy.

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Paper provided by Dalhousie, Department of Economics in its series Department of Economics at Dalhousie University working papers archive with number totrisk.

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Length: 41 pages
Date of creation: 09 Jan 2002
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Handle: RePEc:dal:wparch:totrisk

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Find related papers by JEL classification:
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F49 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Other

This paper has been announced in the following NEP Reports:

NEP-ALL-2002-06-13 (All new papers)

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