How Important Are Terms Of Trade Shocks?

Abstract

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 emerging and countries and find that terms-of-trade shocks explain less than 10 percent of movements in aggregate activity.We then build a three-sector open economy model and estimate key structural parameters country by country.We find that at the country level there is a disconnect between the empirical and theoretical models in the importance assigned to terms-of-trade shocks.