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Terms of Trade Risk

Listed author(s):
  • Benjamin Dennis

    ()

    (Department of Economics, University of the Pacific)

  • Talan Iscan

    ()

    (Department of Economics, Dalhousie University)

This paper analyzes income and consumption risk resulting from fluctuations in the terms-of-trade in a small open economy when factors can be reallocated after incurring a fixed cost. This fixed cost of relocation across sectors introduces partial labor mobility and sector-specific uncertainty. We find that these risks can be significant, even with small adjustment costs and moderate degrees of terms-of-trade volatility. When sector-specific risks are uninsurable, factor immobility leads to considerable income disparity and welfare losses on the order of up to a one percent permanent reduction in consumption. Of the total welfare costs faced by an economy with fixed costs of reallocation, the magnitude of these risks alone is comparable to the aggregate welfare costs that a frictionless economy would experience as a result of terms-of-trade fluctuations. Thus, the welfare costs of terms-of-trade fluctuations for an economy with fixed relocation costs are considerably greater than that of a frictionless economy.

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File URL: http://www.economics.dal.ca/RePEc/dal/wparch/totrisk.pdf
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Paper provided by Dalhousie, Department of Economics in its series Department of Economics at Dalhousie University working papers archive with number totrisk.

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Length: 41 pages
Date of creation: 09 Jan 2002
Handle: RePEc:dal:wparch:totrisk
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  1. Dani Rodrik, 1998. "Why Do More Open Economies Have Bigger Governments?," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 997-1032, October.
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  12. Maurice Obstfeld and Kenneth Rogoff., 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research (CIDER) Working Papers C00-112, University of California at Berkeley.
  13. Clinton, Kevin, 2001. "On Commodity-Sensitive Currencies and Inflation Targeting," Staff Working Papers 01-3, Bank of Canada.
  14. Dennis, B.N. & Iscan, T.B., 2000. "The Virtues of Flecibility: Import Dependence and External Shocks," Department of Economics at Dalhousie University working papers archive 2000-6, Dalhousie, Department of Economics.
  15. Randall Gouge & Ian King, 1997. "A Competitive Theory of Employment Dynamics," Review of Economic Studies, Oxford University Press, vol. 64(1), pages 1-122.
  16. Dixit Avinash & Rob Rafael, 1994. "Switching Costs and Sectoral Adjustments in General Equilibrium with Uninsured Risk," Journal of Economic Theory, Elsevier, vol. 62(1), pages 48-69, February.
  17. Orazio Attanasio & Steven J. Davis, 1994. "Relative Wage Movements and the Distribution of Consumption," NBER Working Papers 4771, National Bureau of Economic Research, Inc.
  18. Mendoza, Enrique G., 1997. "Terms-of-trade uncertainty and economic growth," Journal of Development Economics, Elsevier, vol. 54(2), pages 323-356, December.
  19. Lewis, Stephen Jr., 1989. "Primary exporting countries," Handbook of Development Economics, in: Hollis Chenery & T.N. Srinivasan (ed.), Handbook of Development Economics, edition 1, volume 2, chapter 29, pages 1541-1600 Elsevier.
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