Terms of trade, catch-up, and home-market effect: The example of Japan

This paper explores theoretically and empirically the medium- and long-run relation of the terms of trade (ratio of traded goods prices) and economic growth of a pair of countries—one of which experiences a major catch-up process towards the other. Two theoretical interdependencies between the terms of trade and economic growth are offered: the home-market effect and the productivity-shock effect. These two effects are tested against each other in a cointegration analysis on data for Japan and the US from 1971 until 1997. Income is cointegrated with the terms of trade. The relevant empirical channel is the home-market effect. However, financial-market effects appear also to be relevant. J. Japanese Int. Economies 21 (4) (2007) 470–488.