World Prices and Business Cycles of a Small Open Input-Output Economy

The role of terms-of-trade shocks in driving economic fluctuations is revisited through a multisector small open economy (SOE) model, where the various types of goods can all be consumed and employed as inputs. Under this assumption, we show that contrary to conventional wisdom, terms-oftrade shocks may not necessarily trigger an economic boom for the exporting country, if its export goods are intensively employed or consumed domestically. We calibrate and estimate the proposed model using data from 15 emerging countries and find that it performs better than the standard model to explain the different impacts of terms-of-trade shocks across countries documented by Schmitt-Grohe and Uribe (2018).