The development of Asia exposed many commodity-exporting economies to unprecedented changes of their terms of trade. We set up a small open economy model to estimate the magnitude and timing of breaks in the long-run level and variance of the terms of trade. The model’s balanced growth path gives rise to wedges between tradable, headline, and non-tradable rates of inflation and between the growth rates of investment and aggregate output as a result of multiple productivity trends that trigger off
drifts in relative prices as in the data. Using Australian unfiltered aggregate data, we find evidence of an increase in the long-run level and volatility of the terms of trade. Single-equation structural break tests point to a larger increase in the long-run level of the terms of trade. But inferences in general equilibrium rely on many observables that also respond to shifts in the long-run level of the terms of trade.
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