Job Market Paper: Terms of Trade: Price-Compeititiveness Matters

Abstract: Tests of the balance of payments constrained growth model typically focus on income elasticities of demand in the traded sector. The role of price-competitiveness is treated as negligible and often neglected. This paper presents alternative specifications for the terms of trade in conventional import and export demand equations. I show that by taking into consideration the export prices of foreign competitors and prices of domestic substitutes for imports, terms of trade becomes far more relevant in determining import and export demand and the corresponding equilibrium growth rates in a Keynesian framework. The results suggest policy combinations for developing economies given the absence of domestic substitutes for import goods and the dependence on exports as a source of foreign currency.