A country's terms of trade is one of the most important relative
prices in economics, yet economists are largely ignorant of many of
its empirical properties. The ratio of an index of a country's
export prices to the prices of its imported goods defines the net
barter terms of trade (NBTT), which measures the number of units of
imports that can be exchanged for a unit of exports. Particularly
for commodity-exporting developing countries, movements in the NBTT
are key determinants of a country's macroeconomic performance, and
have an important impact on real national incomes. For example,
arabica coffee is the dominant exportable of Ethiopia. The slump in
world arabica coffee prices in 1986-87, largely caused by world
production in excess of consumption, resulted in a 40 percent fall
in Ethiopia's terms of trade. As imports were about 15 percent of
its national expenditure, this adverse movement in its terms of
trade resulted in about a 6 percent decline in Ethiopia's real
income. Such terms of trade-induced shocks to real incomes in
developing countries necessitate a domestic policy response, but in
framing an appropriate response, an important question is how
long-lasting are typical shocks?
International Monetary Fund
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