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Terms of Trade Risk

  • 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
Date of revision:
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.
  2. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research, Working Paper Series qt0sx02651, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
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  7. Harold L. Cole & Maurice Obstfeld, 1989. "Commodity Trade and International Risk Sharing: How Much Do Financial Markets Matter?," NBER Working Papers 3027, National Bureau of Economic Research, Inc.
  8. Townsend, R.M., 1991. "Risk and Insurance in Village India," University of Chicago - Economics Research Center 91-3, Chicago - Economics Research Center.
  9. Baxter, M. & Jermann, U.J., 1993. "The International Diversification Puzzle is Worse than you Think," RCER Working Papers 350, University of Rochester - Center for Economic Research (RCER).
  10. Clinton, Kevin, 2001. "On Commodity-Sensitive Currencies and Inflation Targeting," Staff Working Papers 01-3, Bank of Canada.
  11. Mendoza, Enrique G., 1997. "Terms-of-trade uncertainty and economic growth," Journal of Development Economics, Elsevier, vol. 54(2), pages 323-356, December.
  12. 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.
  13. Bidarkota, Prasad & Crucini, Mario J, 2000. "Commodity Prices and the Terms of Trade," Review of International Economics, Wiley Blackwell, vol. 8(4), pages 647-66, November.
  14. Paul Cashin & Hong Liang & C. John McDermott, 2000. "How Persistent Are Shocks to World Commodity Prices?," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 2.
  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. Benjamin Dennis & Talan Iscan, 2000. "The Virtues of Flexibility: Import Dependence and External Shocks," Department of Economics at Dalhousie University working papers archive eshocks, Dalhousie, Department of Economics.
  17. Goodwin, Barry K. & Roberts, Matthew C. & Coble, Keith H., 2000. "Measurement Of Price Risk In Revenue Insurance: Implications Of Distributional Assumptions," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 25(01), July.
  18. 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.
  19. Orazio Attanasio & Steven J. Davis, 1994. "Relative Wage Movements and the Distribution of Consumption," NBER Working Papers 4771, National Bureau of Economic Research, Inc.
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