DP10655 How Important Are Terms Of Trade Shocks?

Author(s): Stephanie Schmitt-Grohé, Martín Uribe
Publication Date: June 2015
Keyword(s): business cycles., nontradable goods, real exchange rates, Terms of trade
JEL(s): E32, F41, F44
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10655

According to conventional wisdom, terms of trade shocks represent a major source of business cycles in emerging and poor countries. This view is largely based on the analysis of calibrated business-cycle models. We argue that the view that emerges from empirical SVAR models is strikingly different. We estimate country-specific SVARs using data from 38 poor and emerging countries and find that terms-of-trade shocks explain only 10 percent of movements in aggregate activity. We then build a fully-fledged, open economy model with three sectors, importables, exportables, and nontradables, and use data from each of the 38 countries to obtain country-specific estimates of key structural parameters, including those defining the terms-of-trade process. In the estimated theoretical business-cycle models terms-of-trade shocks explain on average 30 percent of the variance of key macroeconomic indicators, three times as much as in SVAR models.