Terms of Trade Volatility, Financial Integration and Macroeconomic Fluctuations: A Global Panel Analysis

Abstract

This study examines the relationship between terms of trade volatility, financial integration and macroeconomic fluctuations for 99 developed and developing economies over the period 1991-2021. The primary aim of the study is to explore the effects of terms of trade volatility on macroeconomic volatility, measured as output volatility, consumption volatility, and investment volatility. Additionally, the study assesses the moderating role of financial integration between terms of trade volatility and macroeconomic volatility. To achieve the objective, this study employed a dynamic panel generalized method of moments approach. The results provide substantial evidence that terms of trade volatility significantly increases macroeconomic volatility. However, the analysis also highlights that the greater international financial integration reduces the negative effect of terms of trade volatility on macroeconomic volatility. This suggests that financially integrated countries are better equipped to withstand terms of trade shocks, thereby minimizing their impact on macroeconomic volatility. The findings have important policy implications for global economies. Policymakers should therefore prioritize enhancing financial integration to cushion the effects of external shocks on economies. It is worth mentioning that by diversifying the exports and augmenting financial markets, countries can mitigate terms of trade volatility and enhance macroeconomic stability. Furthermore, by building up deeper financial integration and resilience-building mechanisms, economies could respond more efficiently to global economic shocks like terms of trade volatility.