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The Dynamics of the U.S. Trade Balance and Real Exchange Rate: The J Curve and Trade Costs?

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  • George A. Alessandria
  • Horag Choi

Abstract

We study how changes in trade barriers contributed to the dynamics of the US trade balance and real exchange rate since 1980 - a period when trade tripled. Using two dynamic trade models, we decompose fluctuations in the trade balance into terms related to trade integration (global and unilateral) and business cycle asymmetries. We find three main results. First, the relatively large US trade deficits as a share of GDP in the 2000s compared to the 1980s mostly reflect a rise in the trade share of GDP. Second, controlling for trade, only about 60 percent of net trade flows are due to business cycle asymmetries. And third, about two-thirds of the contribution of business-cycle asymmetries are a lagged response. For instance, the short-run Armington elasticity is about 0.2 while the long-run is closer to 1.12 with only 6.9 percent of the gap closed per quarter. We show that a two-country IRBC model with a dynamic exporting decision, pricing-to-market, and trade cost shocks can account for the dynamics of the US trade balance, real exchange rate, and trade integration. The model clarifies how permanent and transitory changes in trade barriers affect the trade balance and how to identify changes in trade barriers. We also show the effect of temporary trade policies on the trade balance depends on whether they induce a trade war.

Suggested Citation

  • George A. Alessandria & Horag Choi, 2019. "The Dynamics of the U.S. Trade Balance and Real Exchange Rate: The J Curve and Trade Costs?," NBER Working Papers 25563, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:25563
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    Cited by:

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    3. Lee E. Ohanian & Paulina Restrepo-Echavarria & Mark L. J. Wright, 2018. "Bad Investments and Missed Opportunities? Postwar Capital Flows to Asia and Latin America," American Economic Review, American Economic Association, vol. 108(12), pages 3541-3582, December.
    4. Eaton, Jonathan & Kortum, Samuel & Neiman, Brent, 2016. "Obstfeld and Rogoff׳s international macro puzzles: a quantitative assessment," Journal of Economic Dynamics and Control, Elsevier, vol. 72(C), pages 5-23.
    5. Lee Ohanian & Diana Van Patten & Mark Wright & Paulina Restrepo-Echavarria, 2019. "Bretton Woods and the Reconstruction of Europe," 2019 Meeting Papers 665, Society for Economic Dynamics.
    6. Su, Thanh Dinh & Nguyen, Canh Phuc, 2021. "Twin balances, public governance and private investment: Quantile estimation for OECD countries," International Economics, Elsevier, vol. 165(C), pages 85-93.
    7. Miyamoto, Wataru & Nguyen, Thuy Lan, 2017. "Understanding the cross-country effects of U.S. technology shocks," Journal of International Economics, Elsevier, vol. 106(C), pages 143-164.
    8. Petroulakis, Filippos, 2017. "Internal devaluation in currency unions: the role of trade costs and taxes," Working Paper Series 2049, European Central Bank.
    9. Alessandria, George & Avila, Oscar, 2020. "Trade Integration in Colombia: A Dynamic General Equilibrium Study with New Exporter Dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 115(C).
    10. Beshkar, Mostafa & Shourideh, Ali, 2020. "Optimal trade policy with trade imbalances," Journal of Monetary Economics, Elsevier, vol. 109(C), pages 65-82.
    11. Lee E. Ohanian & Paulina Restrepo-Echavarria & Diana Van Patten & Mark L. J. Wright, 2020. "The International Consequences of Bretton Woods Capital Controls and the Value of Geopolitical Stability," Working Papers 2020-042, Federal Reserve Bank of St. Louis.

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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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