Terms of Trade Risk

Benjamin N. Dennis () and Talan B. Iscan ()

Department of Economics at Dalhousie University working papers archive from Dalhousie, Department of Economics

Abstract: This paper analyzes income and consumption risk resulting from fluctuations in the terms-of-trade in a small open economy when factors can be reallocated after incurring a fixed cost. This fixed cost of relocation across sectors introduces partial labor mobility and sector-specific uncertainty. We find that these risks can be significant, even with small adjustment costs and moderate degrees of terms-of-trade volatility. When sector-specific risks are uninsurable, factor immobility leads to considerable income disparity and welfare losses on the order of up to a one percent permanent reduction in consumption. Of the total welfare costs faced by an economy with fixed costs of reallocation, the magnitude of these risks alone is comparable to the aggregate welfare costs that a frictionless economy would experience as a result of terms-of-trade fluctuations. Thus, the welfare costs of terms-of-trade fluctuations for an economy with fixed relocation costs are considerably greater than that of a frictionless economy.

Keywords: terms-of-trade; resource reallocation; fixed costs; labor mobility; uninsurable risk (search for similar items in EconPapers)
JEL-codes: F41 F49 (search for similar items in EconPapers)
Date: 2002-01-09
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