Terms of Trade Shocks and Incomplete Information

Daniel Rees

RBA Research Discussion Papers from Reserve Bank of Australia

Abstract: The terms of trade are subject to both permanent and transitory shocks. Particularly for commodity-producing small open economies, it is sometimes argued that the inability of agents to determine which of these shocks are permanent and which are transitory leads to more macroeconomic volatility than would be the case if agents had perfect information about the persistence of these shocks. I set up a small open economy model in which agents have imperfect information about the persistence of terms of trade shocks and estimate the parameters of the model using Australian data. The results point to the existence of large informational frictions. In fact, agents' beliefs about the future path of the terms of trade following transitory and permanent shocks are almost identical. However, the results also suggest that incomplete information causes agents to respond more cautiously to terms of trade shocks. Consequently, consumption, output and the trade balance are less volatile under incomplete information than they are under full information.

Keywords: terms of trade; imperfect information; small open economy; real business cycle (search for similar items in EconPapers)
JEL-codes: C32 E32 F41 Q33 (search for similar items in EconPapers)
Date: 2013-07
New Economics Papers: this item is included in nep-cta, nep-dge and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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