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Macroeconomic Volatility and Terms of Trade Shocks

Author

Listed:
  • Dan Andrews

    (Reserve Bank of Australia)

  • Daniel Rees

    (Reserve Bank of Australia)

Abstract

This paper explores the effect of terms of trade volatility on macroeconomic volatility using a panel of 71 countries from 1971–2005. It finds that terms of trade volatility has a statistically significant and positive impact on the volatility of output growth and inflation, although the magnitudes of these effects depend on the policy framework and the structure of markets. Specifically, adopting a more flexible exchange rate tends to ameliorate the effect of terms of trade shocks on macroeconomic volatility. The paper also finds some evidence that a monetary policy regime that focuses on low inflation helps to moderate the volatility of output and inflation in the face of a volatile terms of trade. The same is true of financial market development in the case of output volatility. Using data on the expenditure components of GDP, the channels through which terms of trade shocks affect output are examined. The results suggest that terms of trade volatility has its largest effect on the volatility of consumption, exports and imports. There is evidence to suggest that greater financial market development helps to mitigate the effect of terms of trade volatility on consumption volatility, while monetary policy that focuses on low inflation is associated with lower volatility of imports.

Suggested Citation

  • Dan Andrews & Daniel Rees, 2009. "Macroeconomic Volatility and Terms of Trade Shocks," RBA Research Discussion Papers rdp2009-05, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp2009-05
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    File URL: https://www.rba.gov.au/publications/rdp/2009/pdf/rdp2009-05.pdf
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    References listed on IDEAS

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    1. Grimes, Arthur, 2006. "A smooth ride: Terms of trade, volatility and GDP growth," Journal of Asian Economics, Elsevier, vol. 17(4), pages 583-600, October.
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    5. Christopher Kent & Kylie Smith & James Holloway, 2005. "Declining Output Volatility: What Role for Structural Change?," RBA Research Discussion Papers rdp2005-08, Reserve Bank of Australia.
    6. Christopher Kent & Kylie Smith & James Holloway, 2005. "Declining Output Volatility: What Role for Structural Change?," RBA Annual Conference Volume,in: Christopher Kent & David Norman (ed.), The Changing Nature of the Business Cycle Reserve Bank of Australia.
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    8. Jonathan David Ostry & Anne Marie Gulde & Atish R. Ghosh & Holger C. Wolf, 1995. "Does the Nominal Exchange Rate Regime Matter?," IMF Working Papers 95/121, International Monetary Fund.
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    12. Broda, Christian, 2004. "Terms of trade and exchange rate regimes in developing countries," Journal of International Economics, Elsevier, vol. 63(1), pages 31-58, May.
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    14. repec:hrv:faseco:34721963 is not listed on IDEAS
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    Citations

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    Cited by:

    1. Kiran Ijaz & Muhammad Zakaria & Bashir A. Fida, 2014. "Terms-of-Trade Volatility and Inflation in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 19(1), pages 111-132, Jan-June.
    2. Lahura, Erick & Vega, Marco, 2013. "Regímenes cambiarios y desempeño macroeconómico: Una evaluación de la literatura," Revista Estudios Económicos, Banco Central de Reserva del Perú, issue 26, pages 101-119.
    3. Victor Pontines & Reza Siregar, 2012. "Exchange Rate Appreciation, Capital Flows and Excess Liquidity: Adjustment and Effectiveness of Policy Responses," Research Studies, South East Asian Central Banks (SEACEN) Research and Training Centre, number rp87, April.
    4. Douglas Sutherland & Peter Hoeller, 2014. "Growth Policies and Macroeconomic Stability," OECD Economic Policy Papers 8, OECD Publishing.
    5. Camilo Alberto Cárdenas-Hurtado & Aaron Levi Garavito-Acosta & Jorge Hernán Toro-Córdoba, 2018. "Asymmetric Effects of Terms of Trade Shocks on Tradable and Non-tradable Investment Rates: The Colombian Case," Borradores de Economia 1043, Banco de la Republica de Colombia.
    6. Patricia Gómez-González & Daniel Rees, 2013. "Stochastic Terms of Trade Volatility in Small Open Economies," RBA Research Discussion Papers rdp2013-10, Reserve Bank of Australia.
    7. Nabil ALIMI, 2016. "The Effect Of Economic Freedom On Business Cycle Volatility: Case Of Developing Countries," Region et Developpement, Region et Developpement, LEAD, Universite du Sud - Toulon Var, vol. 43, pages 139-158.
    8. Jorge Toro & Aarón Garavito & David Camilo López & Enrique Montes, 2015. "El choque petrolero y sus implicaciones en la economía colombiana," BORRADORES DE ECONOMIA 013829, BANCO DE LA REPÚBLICA.
    9. María Franco Chuaire & Carlos Scartascini & Mariano Tommasi, 2017. "State capacity and the quality of policies. Revisiting the relationship between openness and government size," Economics and Politics, Wiley Blackwell, vol. 29(2), pages 133-156, July.
    10. Douglas Sutherland & Peter Hoeller, 2013. "Growth-promoting Policies and Macroeconomic Stability," OECD Economics Department Working Papers 1091, OECD Publishing.
    11. Ferreira Filipe, Sara, 2012. "Equity order flow and exchange rate dynamics," Journal of Empirical Finance, Elsevier, vol. 19(3), pages 359-381.
    12. Maria Franco & Carlos Scartascini & Mariano Tommasi, 2014. "State Capacity and the Quality of Policies: Revisiting the Relationship between Openness and the Size of Government," IDB Publications (Working Papers) 86254, Inter-American Development Bank.
    13. repec:taf:jitecd:v:26:y:2017:i:5:p:534-551 is not listed on IDEAS

    More about this item

    Keywords

    terms of trade shocks; growth; inflation; structural reform;

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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