Euro Area and U.S. External Adjustment: The Role of Commodity Prices and Emerging Market Shocks

Abstract

The trade balances of the Euro Area (EA) and of the U.S. have improved markedly after the Global Financial Crisis. This paper quantifies the drivers of EA and U.S. economic fluctuations and external adjustment, using an estimated (1999-2017) three-region (U.S., EA, rest of world) DSGE model with trade in manufactured goods and in commodities. In the model, commodity prices reflect global demand and supply conditions. The paper highlights the key contribution of the post-crisis collapse in commodity prices for the EA and U.S. trade balance reversal. Aggregate demand shocks originating in Emerging Markets too had a significant impact on EA and U.S. trade balances. The broader lesson of this paper is that Emerging Markets and commodity shocks are major drivers of advanced countries’ trade balances and terms of trade.

Keywords: EA and U.S. external adjustment, commodity markets, emerging markets

JEL Classification: F2, F3, F4