Terms‐of‐Trade Shocks and Exchange Rate Regimes in a Small Open Economy*

Abstract

We examine the impact of terms‐of‐trade shocks on key macroeconomic variables by numerically solving a dynamic stochastic general equilibrium model of a small open economy. The model considers nominal price rigidity under different exchange rate regimes. The numerical solutions obtained are consistent with the empirical regularities documented by Broda (2004), in which output responses to shocks are smoother in floats than in pegs; in moving from pegs to floats, the rise in nominal exchange rate volatility is coupled by the rise in real exchange rate volatility; and in both exchange rate regimes, net foreign assets is the most volatile variable.

The Sources of Business Cycles in a Low Income Country

“…Another strand of the literature employs structural VAR (SVAR) or theoretical models (e.g. see for instance, Broda (2004) Deaton and Miller (1996) Ho¤maister and Roldós (1997);Ho¤maister et al (1998), Houssa (2008, 2009), Houssa et al (2010, Houssa et al (2013), Kose (2002), Kose and Riezman (2001), Mendoza (1995), Chia and Alba (2006)) and highlights the importance of two types of shocks: productivity shocks and terms of trade shocks.…”

A Model for Monetary Policy Analysis for Sub-Saharan Africa

“…Within this framework Kose (2002) finds that terms of trade shocks account for about 88% of output fluctuations in developing countries whereas Kose and Riezman (2001) find that the same shocks account for 45% of output variations in SSA. Chia and Alba (2006) also employ a calibrated version of an open economy DSGE model to analyze the role of exchange rate regimes in coping with terms of trade shocks. Their results are in line with Broda (2004) in the sense that output responses to terms of trade shocks are smoother in floats than in pegs.…”

Asymmetric Effects of Terms of Trade Shocks on Tradable and Non-tradable Investment Rates: The Colombian Case

“…Terms of trade (ToT) shocks play a key role when assessing the external vulnerabilities that face commodity-exporter countries. There is a wide and extensive amount of literature that has documented how ToT dynamics are closely related to business cycles in these countries and how the volatility of macroeconomic aggregates increase due to ToT shocks (Mendoza, 1995;Kose, 2002;Chia and Alba, 2006). These shocks propagate across the economy through multiple channels, and this is precisely what allows for asymmetries and differentials in the responses of macroeconomic variables.…”