What determines the sensitivity of the real exchange rate in Colombia to a terms of trade shock?

We show that the sensitivity of the real exchange rate to terms of trade shocks is greater the lower the elasticity of final and derived demand between domestic and imported items. We develop a novel Kalman filter-based method to estimate these key parameters for Colombia, taking account of preference shifts, technological relative price trends and errors in sectoral data. We find that the elasticity of the input of the distribution sector in transforming imports from domestic consumption reliably indicates complementarity, implying that rigidities in this sector matter in determining the sensitivity of the Colombian economy to external shocks.