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

  • Jarkko Jääskelä

    (Reserve Bank of Australia)

  • Penelope Smith

    (Reserve Bank of Australia)

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    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.

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    File URL: http://www.rba.gov.au/publications/rdp/2011/pdf/rdp2011-05.pdf
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    Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2011-05.

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    Date of creation: Dec 2011
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    Handle: RePEc:rba:rbardp:rdp2011-05
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    1. Christian Gillitzer & Jonathan Kearns, 2005. "Long-term Patterns in Australia’s Terms of Trade," RBA Research Discussion Papers rdp2005-01, Reserve Bank of Australia.
    2. Peersman, Gert, 2003. "What Caused the Early Millennium Slowdown? Evidence Based on Vector Autoregressions," CEPR Discussion Papers 4087, C.E.P.R. Discussion Papers.
    3. 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.
    4. Mardi Dungey & Adrian Pagan, 2009. "Extending a SVAR Model of the Australian Economy," The Economic Record, The Economic Society of Australia, vol. 85(268), pages 1-20, 03.
    5. Gert Peersman & Ine Van Robays, 2009. "Oil and the Euro area economy," Economic Policy, CEPR;CES;MSH, vol. 24, pages 603-651, October.
    6. 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 1053-69, June.
    7. 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.
    8. Leon Berkelmans, 2005. "Credit and Monetary Policy: An Australian SVAR," RBA Research Discussion Papers rdp2005-06, Reserve Bank of Australia.
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