IMF Working Papers

The Terms of Trade and Economic Fluctuations

Author/Editor:

Enrique G. Mendoza

Publication Date:

November 1, 1992

Summary:

A three-good, stochastic intertemporal equilibrium model of a small open economy is used to examine the link between terms of trade and business cycles. Equilibrium co-movements of model economies representing industrial and developing countries are computed and compared with the stylized facts of 30 countries. The results show that terms-of-trade shocks account for half of observed output variability and that the model mimics the Harberger-Laursen-Metzler effect and produces large deviations from purchasing power parity. The elasticity of substitution between tradable and nontradable goods and the persistence of the shocks play a key role in producing these results.

Series:

Working Paper No. 1992/098

Subject:

Business cycles Consumption Economic growth Import prices International trade National accounts Prices Terms of trade Trade balance

Notes:

A three-good, stochastic intertemporal equilibrium model of a small open economy is used to examine the link between terms of trade and business cycles.