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The paper investigates the impact of terms of trade shock on real GDP, consumer price index (CPI) and real effective exchange rate. Based on VAR model, this paper analyzes the impact of terms of trade on macroeconomic volatility before and after the exchange rate regime reform in China. Before the second quarter 2005, the impulse response analysis shows that the responses of 1% shock of terms of trade result in 0.147%, 0.472% and 0.061% decrease in real effective exchange rate, real GDP, and consumer price index, respectively. After the exchange rate regime reform, the shock leads to 0.181% increases in real effective exchange rate, and 0.068%, 0.082% decrease in real GDP and consumer price index, respectively. The results of variance decomposition indicate that after the exchange rate regime reform, the influence of terms of trade to real GDP has been declined sharply, but as to consumer price index the influence has been bigger than before the reform.
