Is the Terms of Trade (TOT) really a cyclical factor affecting the BOP? (1 Viewer)

[Flise]

The 2022 Dixon textbook asserts: "The greatest influence on Australia’s balance of payments in recent years has been changes in Australia’s terms of trade."

What I can't seem to comprehend is how an 'indicator' (the TOT is calculated by dividing the export price index over the import price index) can be a cause of changes in the trade balance. Would it not be more appropriate to attribute the factors that had precipitated the change in the TOT as the cause of the change in the BOP?

 

[fuzi]

The best way to think of it is that the ToT can sort of help us interpret a change in the trade balance (or BOGS). If we look at an improved ToT for example, that means that either the price of Australia's exports has increased or the cost of our imports has decreased, or perhaps even both. Looking at the exports, that means with an improved ToT, Australia receives more revenue for its exports, leading to an improvement in the BOGS, hence the Current Account, hence the BOP, and similarly for cheaper imports, less outflows going towards imports, etc. There are other mechanisms through which a changed ToT can influence the BOPS as well, like through economic growth, structural change or policy changes.

I do get what you mean by the fact it's a bit odd to use an indicator/index, when really its the causes of the change in ToT that causes the change in the BOGS, but the changes in ToT really represents these changes, and I guess the markers prefer if you're using more economics terminology? You could always get really technical and talk about how a change in ToT can influence investor confidence and therefore change inflows and outflows on the CFA, but that would be quite a bit of effort in an exam. When you do talk about it in terms of the ToT, you kind of talk about it terms of the causes of the change in ToT anyways, so it sort of works out the same I guess?

Not sure if that was helpful or not but yeah!