Terms of trade volatility, government spending cyclicality, and economic growth

• Author: Markus Brueckner,Francisco Carneiro
• DOI: http://doi.org/10.1111/roie.12291
• Date: 01 November 2017
• Published date: 01 November 2017

ORIGINAL ARTICLE

Terms of trade volatility, government spending

cyclicality, and economic growth

Markus Brueckner

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Francisco Carneiro

2

1

Australian National University,

Canberra, Australia

2

The World Bank, Washington, DC, U.S.A.

Correspondence

Markus Brueckner, Australian National

University, Research Scholl of

Economics, Kingsely Street, Canberra,

ACT 0200, Australia.

Email: markus.brueckner@anu.edu.au

JEL Classification: H1, F4, O4

Abstract

This paper presents estimates of the effects that terms of

trade volatility has on real gross domestic product (GDP)

per capita growth. Based on 5-year nonoverlapping panel

data comprising 175 countries during 1980 to 2010, the

paper finds that terms of trade volatility has significant nega-

tive effects on economic growth in countries with

procyclical government spending. In countries where gov-

ernment spending is countercyclical, terms of trade volatility

has no significant effect on growth. Conditional on the medi-

ating role of government spending cyclicality, the GDP

share of domestic credit to the private sector has no signifi-

cant effect on the relationship between growth and terms of

trade volatility.

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INTRODUCTION

Variation in terms of trade volatility, across countries and time, is significant. Figure 1 plots the 5-year

standard deviation of the annual growth rate of the terms of trade during 1980–2010 for a sample of

175 countries. The figure shows that for the average country terms of trade volatility has generally

declined since the 1980s, although there has been a spike in later part of the 2000s. Figure 2 shows

that the variation across countries’terms of trade volatility is substantial, and larger in the cross-section

than in the time series.

Understanding the macroeconomic consequences of terms of trade volatility represents one of the

key challenges facing p olicymakers. A commonly held view is that terms of trade volatil ity is associ-

ated with lower economic growth, especially in less developed economies. Terms of trade volatility in

these countries leads to much more unstable growth paths than in developed economies. Moreover, by

reducing economic growth in these countries, volatility can also affect future consumption. It is there-

fore not surprising that the welfare gains from reducing volatility in developing countries can be sub-

stantial (see, e.g., Athanasoulis & Van Wincoop, 2000).

This paper presents panel estimates of the effects that terms of trade volatility has on economic

growth. Theoretical literature, tobe discussed in detail in Section 2, suggests that terms of trade volatility

Rev Int Econ. 2017;25:975–989. wileyonlinelibrary.com/journal/roie V

C2017 JohnWiley & Sons Ltd

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975

Received: 29 July 2016

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Revised: 7 March 2017

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Accepted: 8 March 2017

DOI: 10.1111/roie.12291