Publication: Managing Terms of Trade Volatility
Terms of trade shocks may slow growth, worsen the distribution of income, and raise the odds of highly disruptive currency crises. This note raises questions on how can countries cope with terms of trade shocks; if commodity price stabilization funds can help; and, how can the private sector hedge. Countries need banks, governments, and hedging instruments to strategically cope with volatile external environments in the management of commodity price shocks. Banks should impose capital and liquidity requirements, and encourage internationalization of the domestic banking system, and, governments should promote transparency, delegating fiscal decision-making, by restricting the executive from spending, to avoid inconsistent deficits with inter-termporal solvency. Another strategy is to promote self-insurance, by creating commodity price stabilization funds that forbid the government from spending more than a specified portion of the income that it earns from a key commodity. But there is good reason to implement policies that promote hedging by the private sector, provided the public sector responds with the legal, and institutional framework, enabling appropriate risk management, i.e., both hedging, and self-insurance, even if strategies require that political economy, and technical obstacles be overcome.
“Hausmann, Ricardo. 1999. Managing Terms of Trade Volatility. PREM Notes; No. 18. © World Bank, Washington, DC. http://openknowledge.worldbank.org/entities/publication/7e4320c0-579f-5ef2-90bd-99ba2b96b9c6 License: CC BY 3.0 IGO.”
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