The cyclicality of the income elasticity of trade

In the five years 2011-2015 global trade fell short of expectations to a much larger extent than global GDP. We show that two key features of real trade flows - their high volatility and their procyclicality - are the cause behind the cyclicality of the income elasticity of trade. This property implies that when real GDP growth is positive but below its long-run trend, then the income elasticity of trade is also below its own long-run trend. Therefore, when real GDP growth turns out to be weaker than expected, the forecast error on trade volumes is amplified by the fact that the income elasticity of trade also happens to be lower than predicted. We then analyze the implications of our findings for cross-country differences in the elasticity, the role played by long-run and cyclical factors in the weakness of trade in the aftermath of the Great Recession, and the accuracy of existing trade forecasts, which we significantly improve by exploiting real-time data on business conditions.