Emerging Economies Business Cycles: The Role of the Terms of Trade Revisited

Alejandro Vicondoa

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2016-08-11 - Common wisdom and standard models suggest that terms-of-trade (TOT) shocks are an important source of cyclical fluctuations in small open economies. Recently, Schmitt-Grohe and Uribe (2015) have challenged this hypothesis by showing that in the data unexpected TOT shocks explain only 10% of output movements in emerging countries. We confirm their findings for a sample of Latin American countries and show that TOT news shocks account for 26% of output fluctuations. TOT news shocks are identified as the shocks that best explain future movements in the TOT over an horizon of five quarters and that are orthogonal to current TOT. Augmenting the standard small open economy model with labor adjustment costs, we match theoretical and empirical predictions for both shocks.