The effects of terms of trade shocks in Norway: an SVAR analysis

Abstract

In this thesis I estimate the dynamic effects of three types of terms of trade shocks to the Norwegian economy: a world demand shock, an oil price shock and a globalization shock. Furthermore, the analysis seeks to evaluate the relative importance of these shocks, compared to domestic shocks. The domestic shocks evaluated are a demand shock, a supply shock and a monetary policy shock.

In order to evaluate the effects of these six shocks on mainland GDP growth, inflation, the real exchange rate and the interest rate, a structural VAR model (SVAR) is developed. Norway is a small and open economy, and a key feature of this model is therefore that foreign variables and shocks are exogenously determined in the global economy. All six shocks are identified through sign restrictions, and the model is estimated over the period 1994Q1-2012Q4.

I find that all three foreign shocks affect the Norwegian terms of trade, and foreign output growth. While the terms of trade shocks are important for the Norwegian economy, the results indicate a clearly more important role for domestic factors. All foreign shocks contribute with sizable shares of variation in the domestic variables of interest, but at the same time the shocks affect the economy differently. While all positive shocks improve Norwegian terms of trade, they affect GDP growth, inflation and the exchange rate differently. This in turn induce different response of monetary policy, both in the immediate aftermath of the shock, and in the longer run. Thus, the findings in this thesis highlight the importance of disentangling the source of the terms of trade shock, in order for economic policy to respond correctly.