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Stochastic Terms of Trade Volatility in Small Open Economies

Author

Listed:
  • Patricia Gómez-González

    (Massachusetts Institute of Technology)

  • Daniel Rees

    (Reserve Bank of Australia)

Abstract

The terms of trade of commodity-producing small open economies are subject to large shocks that can be an important source of economic fluctuations. Alongside times of high volatility, however, these economies also experience periods in which their terms of trade are comparatively stable. We estimate the empirical process for the terms of trade for six small open economies and examine the responses of output, the current account and prices to changes in terms of trade volatility using a vector autoregression (VAR). We find that increased terms of trade volatility, by itself, is associated with a contraction in domestic demand and an increase in the current account. We then set up a small open economy real business cycle model and show that it can broadly replicate the responses to a volatility shock estimated in the VAR. We use this model to explore the sectoral implications of terms of trade volatility shocks and to quantify the importance of these shocks as a source of business cycle fluctuations. Our results suggest that the direct effects of terms of trade volatility shocks on output, consumption and investment are generally small. But, interacted with shocks to the level of the terms of trade, volatility shocks account for around one-quarter of the total impact of the terms of trade on macroeconomic outcomes.

Suggested Citation

  • 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.
  • Handle: RePEc:rba:rbardp:rdp2013-10
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    File URL: http://www.rba.gov.au/publications/rdp/2013/pdf/rdp2013-10.pdf
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    References listed on IDEAS

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    Cited by:

    1. Ramezani, Fariba & Harvie, Charles & Arjomandi, Amir, 2016. "Australian Emissions Reduction Subsidy Policy under Persistent Productivity Shocks," 2016 Conference (60th), February 2-5, 2016, Canberra, Australia 235585, Australian Agricultural and Resource Economics Society.
    2. repec:eee:eecrev:v:101:y:2018:i:c:p:157-180 is not listed on IDEAS

    More about this item

    Keywords

    terms of trade; small open economy; real business cycle; stochastic volatility;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)

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