Growth prospects and the trade balance in advanced economies

Does an improvement in growth prospects lead to a fall in the trade balance? The relevance of this question stems from the tendency for countercyclical fluctuations in the trade balance stressed by both the academic literature and policymakers. However, we do not find that improved growth prospects (news shocks) necessarily lead to negative trade balance effects in the G7 countries. We develop a novel news shocks identification scheme, apply it to country-level vector autoregressions (VARs), and obtain the following results. While in the U.S., news shocks induce a persistent deterioration of the trade balance, the negative trade balance effect in Germany is only temporary. By contrast, in other G7 countries, news shocks induce positive and transitory trade balance effects. Consumption smoothing and substantial fluctuations in investment and labor input are important drivers of these results for the U.S., and less so in other G7 countries. Therefore, policy recommendations to reduce the trade imbalances through productivity-enhancing reforms in advanced economies are likely to yield only temporary effects.