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Terms of Trade Shocks: What are They and What Do They Do?

Author

Listed:
  • Jarkko Jääskelä

    (Reserve Bank of Australia)

  • Penelope Smith

    (Reserve Bank of Australia)

Abstract

This paper describes and quantifies the macroeconomic effects of different types of terms of trade shocks and their propagation in the Australian economy. Three types of shocks are identified based on their impact on commodity prices, global manufactured prices, and global economic activity. The first two shocks, a world demand shock and a commodity-market specific shock are fairly standard. The third shock, a globalisation shock that may result, for instance, from the increasing importance of China, India and eastern Europe in the global economy is more novel. The globalisation shock is associated with a decline in manufactured prices, a rise in commodity prices, and an increase in global economic activity. Determining the underlying source of variation in the terms of trade is shown to be important for understanding the impact on the Australian economy as all three shocks propagate through the economy in different ways. The relative contribution of each shock to inflation, output, interest rates, and the exchange rate has also varied over time. The main conclusion of the paper is that a higher terms of trade tends to be expansionary but is not always inflationary. A key result is that the floating exchange rate has provided an important buffer to the external shocks that move the terms of trade.

Suggested Citation

  • Jarkko Jääskelä & Penelope Smith, 2011. "Terms of Trade Shocks: What are They and What Do They Do?," RBA Research Discussion Papers rdp2011-05, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp2011-05
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    File URL: http://www.rba.gov.au/publications/rdp/2011/pdf/rdp2011-05.pdf
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    References listed on IDEAS

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    3. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-1069, June.
    4. Andrea Brischetto & Graham Voss, 1999. "A Structural Vector Autoregression Model of Monetary Policy in Australia," RBA Research Discussion Papers rdp1999-11, Reserve Bank of Australia.
    5. Christian Gillitzer & Jonathan Kearns, 2005. "Long-term Patterns in Australia’s Terms of Trade," RBA Research Discussion Papers rdp2005-01, Reserve Bank of Australia.
    6. Mardi Dungey & Adrian Pagan, 2008. "Extending an SVAR Model of the Australian Economy," NCER Working Paper Series 21, National Centre for Econometric Research.
    7. Leon Berkelmans, 2005. "Credit and Monetary Policy: An Australian SVAR," RBA Research Discussion Papers rdp2005-06, Reserve Bank of Australia.
    8. Philip Liu, 2010. "The Effects of International Shocks on Australia's Business Cycle," The Economic Record, The Economic Society of Australia, vol. 86(275), pages 486-503, December.
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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. Osborn, Denise R. & Vehbi, Tugrul, 2015. "Growth in China and the US: Effects on a small commodity exporter economy," Economic Modelling, Elsevier, vol. 45(C), pages 268-277.
    3. Peter Downes & Kevin Hanslow & Peter Tulip, 2014. "The Effect of the Mining Boom on the Australian Economy," RBA Research Discussion Papers rdp2014-08, Reserve Bank of Australia.
    4. Knop, Stephen J. & Vespignani, Joaquin L., 2014. "The sectorial impact of commodity price shocks in Australia," Economic Modelling, Elsevier, vol. 42(C), pages 257-271.
    5. Denise R Osborn & Tugrul Vehbi, 2013. "Empirical Evidence on Growth Spillovers from China to New Zealand," Treasury Working Paper Series 13/17, New Zealand Treasury.
    6. Peter Tulip, 2014. "The Effect of the Mining Boom on the Australian Economy," RBA Bulletin, Reserve Bank of Australia, pages 17-22, December.
    7. Kulish, Mariano & Rees, Daniel M., 2017. "Unprecedented changes in the terms of trade," Journal of International Economics, Elsevier, pages 351-367.

    More about this item

    Keywords

    terms of trade; sign-restricted VAR;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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