On the impact of volatility on the real exchange rate – terms of trade nexus: Revisiting commodity currencies

The aim of this paper is to study the relationship between terms of trade and real exchange rates in commodity-producing countries on both the short and the long run. We investigate potential non-linearity in the real exchange rate – terms of trade nexus according to the level of volatility in commodity and financial markets. To this end, we consider a panel of 68 commodity exporters, split in sub-samples of advanced, intermediate and low-income countries. We first show that there is a long-run relationship between real exchange rates and terms of trade, taking also into account productivity and net foreign assets. Then, we run panel smooth transition regressions to estimate the adjustment process of the real effective exchange rate to its equilibrium value depending on different proxies of volatility. Our results show that only advanced oil-exporters' currencies are sensitive to changes in terms of trade in the short run especially when volatility is high on commodity markets.