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What determines the sensitivity of the real exchange rate in Colombia to a terms of trade shock?

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  • Lavan Mahadeva
  • Juan Carlos Parra Alvarez

Abstract

We show that the sensitivity of the real exchange rate to terms of trade shocks is greater the lower the elasticity of final and derived demand between domestic and imported items. We develop a novel Kalman filter-based method to estimate these key parameters for Colombia, taking account of preference shifts, technological relative price trends and errors in sectoral data. We find that the elasticity of the input of the distribution sector in transforming imports from domestic consumption reliably indicates complementarity, implying that rigidities in this sector matter in determining the sensitivity of the Colombian economy to external shocks.

Suggested Citation

  • Lavan Mahadeva & Juan Carlos Parra Alvarez, 2012. "What determines the sensitivity of the real exchange rate in Colombia to a terms of trade shock?," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 5(2), pages 161-176, April.
  • Handle: RePEc:taf:macfem:v:5:y:2012:i:2:p:161-176
    DOI: 10.1080/17520843.2012.682595
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    References listed on IDEAS

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    4. Devarajan, Shantayanan & Lewis, Jeffrey & Robinson, Sherman, 1990. "Policy Lessons from Two-Sector Models," CUDARE Working Papers 198566, University of California, Berkeley, Department of Agricultural and Resource Economics.
    5. Kim, Chang-Jin & Nelson, Charles R., 2006. "Estimation of a forward-looking monetary policy rule: A time-varying parameter model using ex post data," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1949-1966, November.
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