International trade is frequently thought of as a production technology in which the inputs are exports and the outputs are imports. Exports are transformed into imports at the rate of the price of exports relative to the price of imports: the reciprocal of the terms of trade. Cast this way, a change in the terms of trade acts as a productivity shock. Or does it? In this paper, we show that this line of reasoning cannot work in standard models. Starting with a simple model and then generalizing, we show that changes in the terms of trade have no first-order effect on productivity when output is measured as chain-weighted real gross domestic product. The terms of trade do affect real income and consumption in a country, and we show how measures of real income change with the terms of trade at business cycle frequencies and during financial crises.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13111.
Length: Date of creation: May 2007 Date of revision: Handle: RePEc:nbr:nberwo:13111
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Find related papers by JEL classification: E23 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Production F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
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