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Not all Terms of Trade Shocks are Alike

Author

Listed:
  • Juvenal, Luciana

    (International Monetary Fund)

  • Petrella, Ivan

    (University of Warwick)

Abstract

Fluctuations in terms of trade are one of the major sources of concern for policy makers in developing countries. Theoretical models predict that terms of trade shocks account for a large share of business cycle fluctuations. However, recent empirical studies find a weak link between terms of trade and output fluctuations, uncovering the “terms of trade disconnect.” This disconnect happens because not all terms of trade shocks are alike. When analyzing terms of trade shocks, it is implicitly assumed that the economy responds symmetrically to changes in export and import prices. Our paper shows that this is not the case. To shed light on how terms of trade affect the economy, we estimate export price, import price and global demand shocks, which proxy for world disturbances, using a VAR model with sign-restrictions complemented with a narrative approach for a sample of 36 countries. We construct our own measure of export and import prices using commodity and manufacturing prices matched with trade shares. Our findings indicate that, taken together, export and import price shocks account for around 50 percent of output fluctuations. We also find that global demand shocks explain the high correlation between export and import prices since they generate a simultaneous increase in both, yielding a small effect on the terms of trade but large effects on the economy.

Suggested Citation

  • Juvenal, Luciana & Petrella, Ivan, 2019. "Not all Terms of Trade Shocks are Alike," EMF Research Papers 25, Economic Modelling and Forecasting Group.
  • Handle: RePEc:wrk:wrkemf:25
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    File URL: https://warwick.ac.uk/fac/soc/wbs/subjects/finance/mpf/working-papers/emf_wp_25.pdf
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    More about this item

    Keywords

    terms of trade ; commodity prices ; business cycles ; world shocks;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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