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The Terms of Trade as Drivers of Economic Fluctuations in Developing Economies: An Empirical Study

Listed author(s):
  • Paul Castillo Bardález

    (Central Reserve Bank of Peru)

  • Jorge Salas

    (Central Reserve Bank of Peru)

We use quarterly data from Peru to examine the empirical relationship between permanent terms-of-trade shocks and economic fluctuations in developing small open economies. To do this, we estimate a VAR model with common stochastic trends, following the methodology described in King et al. (1991) and Mellander et al. (1992). Our main finding is that permanent terms-of-trade shocks account for the largest share of output, consumption, and investment long-run fluctuations. This result is robust across alternative specifications. Moreover, we show that the variability of potential output growth, as measured through the estimated permanent component of GDP, is highly dependent on the terms of trade swings. Our main results remain unchanged when we estimate the model with data from Chile, although in this case the influence of permanent domestic productivity shocks appears to be more significant than in the Peruvian model.

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This book is provided by Centro de Estudios Monetarios Latinoamericanos, CEMLA in its series Premio de Banca Central Rodrigo Gómez / Central Banking Award "Rodrigo Gómez" with number prg2010eng and published in 2010.
ISBN: 978-607-7734-37-6
Handle: RePEc:cml:prodgz:prg2010eng
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References listed on IDEAS
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  1. Shaghil Ahmed & Radha Murthy, 1994. "Money, Output, and Real Business Cycles in a Small Open Economy," Canadian Journal of Economics, Canadian Economics Association, vol. 27(4), pages 982-993, November.
  2. Timothy J. Kehoe & Kim J. Ruhl, 2008. "Are Shocks to the Terms of Trade Shocks to Productivity?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 804-819, October.
  3. Maurice Obstfeld, 1982. "Aggregate Spending and the Terms of Trade: Is There a Laursen-Metzler Effect?," The Quarterly Journal of Economics, Oxford University Press, vol. 97(2), pages 251-270.
  4. Christopher Blattman & Jason Hwang & Jeffrey G. Williamson, 2004. "The Impact of the Terms of Trade on Economic Development in the Periphery, 1870-1939: Volatility and Secular Change," Harvard Institute of Economic Research Working Papers 2040, Harvard - Institute of Economic Research.
  5. Thomas Lubik & Wing Teo, 2005. "Do World Shocks Drive Domestic Business Cycles? Some Evidence from Structural Estimation," Economics Working Paper Archive 522, The Johns Hopkins University,Department of Economics.
  6. Willy W. Hoffmaister & Jorge Roldos, 1997. "Are Business Cycles Different in Asia and Latin America?," IMF Working Papers 97/9, International Monetary Fund.
  7. Alejandro Izquierdo & Randall Romero & Ernesto Talvi, 2008. "Booms and Busts in Latin America: The Role of External Factors," Research Department Publications 4569, Inter-American Development Bank, Research Department.
  8. Alejandro Izquierdo & Randall Romero & Ernesto Talvi, 2008. "Booms and Busts in Latin America: The Role of External Factors," Research Department Publications 4569, Inter-American Development Bank, Research Department.
  9. Justiniano, Alejandro & Preston, Bruce, 2010. "Can structural small open-economy models account for the influence of foreign disturbances?," Journal of International Economics, Elsevier, vol. 81(1), pages 61-74, May.
  10. Kose, M. Ayhan, 2002. "Explaining business cycles in small open economies: 'How much do world prices matter?'," Journal of International Economics, Elsevier, vol. 56(2), pages 299-327, March.
  11. Timothy J. Kehoe & Kim J. Ruhl, 2008. "Are Shocks to the Terms of Trade Shocks to Productivity?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 804-819, October.
  12. Favero, Carlo A., 2001. "Applied Macroeconometrics," OUP Catalogue, Oxford University Press, number 9780198296850.
  13. Paolo Mauro & Torbjorn I. Becker, 2006. "Output Drops and the Shocks That Matter," IMF Working Papers 06/172, International Monetary Fund.
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