Are Shocks to the Terms of Trade Shocks to Productivity?
International trade is frequently thought of as a production technology in which the inputs are exports and the outputs are imports. Exports are transformed into imports at the rate of the price of exports relative to the price of imports: the reciprocal of the terms of trade. Cast this way, a change in the terms of trade acts as a productivity shock. Or does it? In this paper, we show that this line of reasoning cannot work in standard models. Starting with a simple model and then generalizing, we show that changes in the terms of trade have no first-order effect on productivity when output is measured as chain-weighted real gross domestic product. The terms of trade do affect real income and consumption in a country, and we show how measures of real income change with the terms of trade at business cycle frequencies and during financial crises.
We would like to thank Narayana Kocherlakota, Ellen McGrattan, Edward Prescott, and Katheryn Russ for helpful advice and comments. This work was undertaken with the support of the National Science Foundation under grant SES-0536970. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Timothy J. Kehoe & Kim J. Ruhl, 2008. "Are Shocks to the Terms of Trade Shocks to Productivity?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 804-819, October. citation courtesy of