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Output Volatility and Openness to Trade: A Reassessment

  • Eduardo A. Cavallo


This paper presents new empirical evidencesuggesting that the net effect of trade openness on output volatility is stabilizing. The methodology employed seeks to correct for the likely endogeneity of trade in this setting using gravity estimates as instrumental variables. The results confirm that exposure to trade raises output volatility through the terms-of-trade channel, as previously documented in the literature, but also shows that this is counteracted by a quantitatively larger stabilizing effect. Additional evidence is presented showing that the latter effect comes (at least in part) through the financial channel. Splitting the sample into countries that are more exposed to capital flows and countries that are less exposed, the paper shows that the stabilizing effect of commercial trade predominates in the first sub-sample.

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Paper provided by Inter-American Development Bank, Research Department in its series Research Department Publications with number 4518.

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Date of creation: Apr 2007
Date of revision:
Handle: RePEc:idb:wpaper:4518
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  1. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," Research Department Publications 4367, Inter-American Development Bank, Research Department.
  2. Eduardo A. Cavallo, 2006. "Trade, Gravity and Sudden Stops: On How Commercial Trade Can Increase the Stability of Capital Flows," Research Department Publications 4491, Inter-American Development Bank, Research Department.
  3. Jeffrey D. Sachs, 1985. "External Debt and Macroeconomic Performance in Latin America and East Asia," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 16(2), pages 523-573.
  4. Rodrik, Dani, 1996. "Why do More Open Economies Have Bigger Governments?," CEPR Discussion Papers 1388, C.E.P.R. Discussion Papers.
  5. Jeffrey A. Frankel & Eduardo A. Cavallo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, Or Less? Using Gravity to Establish Causality," NBER Working Papers 10957, National Bureau of Economic Research, Inc.
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  7. Antonio Fatás & Ilian Mihov, 2003. "The Case For Restricting Fiscal Policy Discretion," The Quarterly Journal of Economics, MIT Press, vol. 118(4), pages 1419-1447, November.
  8. Koren, Miklós & Tenreyro, Silvana, 2005. "Volatility and Development," CEPR Discussion Papers 5307, C.E.P.R. Discussion Papers.
  9. Andrew K. Rose, 2001. "One reason countries pay their debts: renegotiation and international trade," Staff Reports 142, Federal Reserve Bank of New York.
  10. Jeffrey Frankel & Andrew Rose, 2002. "An Estimate Of The Effect Of Common Currencies On Trade And Income," The Quarterly Journal of Economics, MIT Press, vol. 117(2), pages 437-466, May.
  11. Buch, Claudia M. & Doepke, Joerg & Pierdzioch, Christian, 2005. "Financial openness and business cycle volatility," Journal of International Money and Finance, Elsevier, vol. 24(5), pages 744-765, September.
  12. Hnatkovska, Viktoria & Loayza, Norman, 2004. "Volatility and growth," Policy Research Working Paper Series 3184, The World Bank.
  13. Marco Terrones & Eswar Prasad & M. Ayhan Kose, 2003. "Financial Integration and Macroeconomic Volatility," IMF Working Papers 03/50, International Monetary Fund.
  14. Michael W. Klein, 2003. "Capital Account Openness and the Varieties of Growth Experience," NBER Working Papers 9500, National Bureau of Economic Research, Inc.
  15. International Monetary Fund, 2004. "Once Again, is Openness Good for Growth?," IMF Working Papers 04/135, International Monetary Fund.
  16. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
  17. Ramey, Garey & Ramey, Valerie A, 1995. "Cross-Country Evidence on the Link between Volatility and Growth," American Economic Review, American Economic Association, vol. 85(5), pages 1138-51, December.
  18. Robert C. Feenstra & Robert E. Lipsey & Harry P. Bowen, 1997. "World Trade Flows, 1970-1992, with Production and Tariff Data," NBER Working Papers 5910, National Bureau of Economic Research, Inc.
  19. Francisco Rodriguez & Dani Rodrik, 1999. "Trade Policy and Economic Growth: A Skeptic's Guide to Cross-National Evidence," NBER Working Papers 7081, National Bureau of Economic Research, Inc.
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