Output Volatility and Openness to Trade: A Reassessment

Eduardo Cavallo

No 4518, Research Department Publications from Inter-American Development Bank, Research Department

Abstract: This paper presents new empirical evidencesuggesting that the net effect of trade openness on output volatility is stabilizing. The methodology employed seeks to correct for the likely endogeneity of trade in this setting using gravity estimates as instrumental variables. The results confirm that exposure to trade raises output volatility through the terms-of-trade channel, as previously documented in the literature, but also shows that this is counteracted by a quantitatively larger stabilizing effect. Additional evidence is presented showing that the latter effect comes (at least in part) through the financial channel. Splitting the sample into countries that are more exposed to capital flows and countries that are less exposed, the paper shows that the stabilizing effect of commercial trade predominates in the first sub-sample.

Date: 2007-04
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Related works:
Journal Article: Output Volatility and Openness to Trade: a Reassessment (2008)
Working Paper: Output volatility and openness to trade: a reassessment (2008)
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