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Emerging economies business cycles: The role of the terms of trade revisited (joint with Nadav Ben Zeev and Alejandro Vicondoa)

Wednesday 7 October 2015, 1.00PM to 2.00pm

Speaker(s): Evi Pappa (EUI Florence)


Schmitt-Grohe and Uribe (2015) estimate annual country-specific SVARs for 38 poor and emerging countries and find that the terms-of-trade shocks explain only 10 % of movements in aggregate activity. On the other hand they show that in standard estimated small open economy models terms-of-trade (TOT) shocks explain on average 30 % of the variance of key macroeconomic indicators, three times as much as in SVAR models. This disconnect between the empirical and theoretical models raises doubts about the validity of the existing models for explaining business cycle dynamics in emerging countries. Our research is motivated by the observation that many movements in the terms of trade are anticipated. It is important to examine whether anticipated movements in the terms of trade matter for business cycle dynamics of small emerging countries. Using quarterly data for Latin American countries we revisit the role of expected and unexpected changes in the terms of trade in propagating business cycle fluctuations. Our identification strategy relies on “medium-run” constraints and builds on Uhlig (2003)  and Barsky and Sims (2011).  News shocks to the terms of trade is identified as the shock that best explains future movements in TOT over a horizon of 5 years and is orthogonal to current value of TOT. We show that TOT news matter more than unexpected TOT shocks for business cycle fluctuations in emerging countries and that  TOT hypothesis as a source of business cycle fluctuations in emerging markets is not dead. A standard small open economy model can replicate our empirical findings.

Host: Michal Horvath

Location: ARRC Auditorium ARC014

Admission: All welcome