Accounting for Trade Deficits

This paper proposes a decomposition for the total trade deficit of a country by using implications of a dynamic trade model. It is shown that the total trade deficit of a country can be decomposed into changes due to its effective terms of trade, its relative trade costs, and its macroeconomic developments with respect to its export partners. The implications for bilateral trade are estimated using both imports and exports data for 188 countries, and the decomposition of total trade deficit is achieved for each counry. Empirical results show evidence for heterogeneity across countries regarding the decomposition of trade deficits, suggesting alternative policy tools to rebalance trade at the country level. A cross-country investigation further suggests that relative trade costs, followed by relative macroeconomic developments, have contributed the most to the heterogeneity of trade imbalances.