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

Author

Listed:
  • Paul Castillo Bardález

    (Central Reserve Bank of Peru)

  • Jorge Salas

    (Central Reserve Bank of Peru)

Abstract

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.

Suggested Citation

  • Paul Castillo Bardález & Jorge Salas, 2010. "The Terms of Trade as Drivers of Economic Fluctuations in Developing Economies: An Empirical Study," Premio de Banca Central Rodrigo Gómez / Central Banking Award "Rodrigo Gómez", Centro de Estudios Monetarios Latinoamericanos, CEMLA, number prg2010eng, octubre-d.
  • Handle: RePEc:cml:prodgz:prg2010eng
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    References listed on IDEAS

    as
    1. 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.
    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. 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.
    4. 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.
    5. 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.
    6. 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," NBER Working Papers 10600, National Bureau of Economic Research, Inc.
    7. 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.
    8. Paolo Mauro & Torbjorn I. Becker, 2006. "Output Drops and the Shocks That Matter," IMF Working Papers 06/172, International Monetary Fund.
    9. 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.
    10. Willy W. Hoffmaister & Jorge Roldos, 1997. "Are Business Cycles Different in Asia and Latin America?," IMF Working Papers 97/9, International Monetary Fund.
    11. 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.
    12. 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.
    13. Favero, Carlo A., 2001. "Applied Macroeconometrics," OUP Catalogue, Oxford University Press, number 9780198296850.
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    Citations

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    Cited by:

    1. José De Gregorio & Felipe Labbé, 2011. "Copper, the Real Exchange Rate and Macroeconomic Fluctuations in Chile," Working Papers Central Bank of Chile 640, Central Bank of Chile.
    2. Castillo, Paul & Rojas, Youel, 2014. "Terms of Trade and Total Factor Productivity: Empirical evidence from Latin American emerging markets," Working Papers 2014-012, Banco Central de Reserva del Perú.
    3. Castillo, Paul & Rojas, Youel, 2014. "Términos de intercambio y productividad total de factores: Evidencia empírica de los mercados emergentes de América latina," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 28, pages 27-46.

    More about this item

    Keywords

    Economic fluctuations; Terms of trade; Small open economy; Common trends;

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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