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

57 Pages Posted: 19 Feb 2019 Last revised: 8 May 2021

See all articles by George A. Alessandria

George A. Alessandria

University of Rochester - Department of Economics

Horag Choi

Monash University, Economics Department

Date Written: February 2019

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

Alessandria, George A. and Choi, Horag, The Dynamics of the U.S. Trade Balance and Real Exchange Rate: The J Curve and Trade Costs? (February 2019). NBER Working Paper No. w25563, Available at SSRN: https://ssrn.com/abstract=3336515

George A. Alessandria (Contact Author)

University of Rochester - Department of Economics ( email )

Harkness Hall
Rochester, NY 14627
United States

Horag Choi

Monash University, Economics Department ( email )

900 Dandenong Road
Caulfield East, Victoria 3145
Australia
+61-3-9903-2848 (Phone)

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