Terms‐of‐Trade Shocks and Exchange Rate Regimes in a Small Open Economy

Wai‐mun Chia and Joseph Alba

The Economic Record, 2006, vol. 82, issue s1, S41-S53

Abstract: We examine the impact of terms‐of‐trade shocks on key macroeconomic variables by numerically solving a dynamic stochastic general equilibrium model of a small open economy. The model considers nominal price rigidity under different exchange rate regimes. The numerical solutions obtained are consistent with the empirical regularities documented by Broda (2004), in which output responses to shocks are smoother in floats than in pegs; in moving from pegs to floats, the rise in nominal exchange rate volatility is coupled by the rise in real exchange rate volatility; and in both exchange rate regimes, net foreign assets is the most volatile variable.

Date: 2006
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