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Are Terms of Trade Rises Inflationary?

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  • David Gruen

    (Reserve Bank of Australia)

  • Jacqueline Dwyer

    (Reserve Bank of Australia)

Abstract

This paper explores the relationship between the terms of trade and inflation. It shows, both analytically and empirically, that the exchange rate response to a change in the terms of trade is crucial to the inflation outcome. It suggests the existence of a ‘threshold’ exchange rate response. Our best estimate is that (other things being equal) a rise in the terms of trade is inflationary if the associated rise in the real exchange rate is less than about 1/3-1/2 of the rise in the terms of trade. However, if appreciation of the real exchange rate is larger than this, the consequent fall in the domestic price of importables is large enough that the terms of trade rise reduces inflation, at least in the short run.

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Bibliographic Info

Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp9508.

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Date of creation: Nov 1995
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Handle: RePEc:rba:rbardp:rdp9508

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Cited by:
  1. David Gruen & Adrian Pagan & Christopher Thompson, 1999. "The Phillips Curve in Australia," RBA Research Discussion Papers rdp1999-01, Reserve Bank of Australia.
  2. Christian Broda, 2002. "Terms of trade and exchange rate regimes in developing countries," Staff Reports 148, Federal Reserve Bank of New York.
  3. Valadkhani, Abbas & Layton, Allan P. & Karunaratne, Neil D., 2005. "Export Price Volatility in Australia: An Application of ARCH and GARCH Models," Economics Working Papers wp05-11, School of Economics, University of Wollongong, NSW, Australia.
  4. Jacqueline Dwyer & Kenneth Leong, 2001. "Changes in the determinants of inflation in Australia," BIS Papers chapters, in: Bank for International Settlements (ed.), Empirical studies of structural changes and inflation, volume 3, pages 1-28 Bank for International Settlements.
  5. Donyina-Ameyaw, Samuel, 2004. "A Small Macroeconmetric Model Of Trade And Inflation In Ghana," The Warwick Economics Research Paper Series (TWERPS) 696, University of Warwick, Department of Economics.

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