U.S. Trade Balance Dynamics: The Role of Fiscal Policy and Productivity Shocks and of Financial Market Linkages

Abstract

This paper examines whether domestic and foreign productivity and fiscal policy changes can account for the wide swings in U.S. net exports during the period 1975-1991. A two-country Real Business Cycle (RBC) model with a government sector is used for that purpose. The analysis focuses on the response of optimizing, forward-looking private decision makers to exogenous shocks, and on the way that this response is affected by international asset market linkages. Historical quarterly series on total factor productivity, government consumption and average tax rates in the U.S. and in an aggregate of the remaining G7 countries (G6, henceforth) are fed into the model. A version of the model in which international asset markets are incomplete, in the sense that only non-contingent debt contracts (bonds) can be used for international financial transactions, tracks the observed behavior of the U.S. trade balance rather closely, provided permanent country-specific productivity shifts are assumed (statistical tests presented in the paper support the assumption of permanent idiosyncratic U.S. and G6 productivity shocks).

The simulations of the structural model suggest that U.S. productivity changes were the major source of fluctuations in U.S. net exports during the period 1975-1991; they show that tax changes too had a noticeable impact on the trade balance but that government spending only played a secondary role. The simulations suggest, in particular, that the relatively rapid productivity growth and the large tax cuts that occurred in the U.S. during the first half of the 1980s were important sources behind the sharp drop in U.S. net exports during that period.

In contrast to the structure with incomplete international asset markets, a version of the model that postulates complete international asset markets, as assumed in many International RBC models (see e.g., Dellas, 1986; Baxter and Crucini, 1993; Backus et al., 1995), fails to explain the observed behavior of the U.S. trade balance--predicted trade balance series generated by that version of the model are negatively correlated with the actual U.S. trade balance.

Note: This is a description of the paper and not the actual abstract.

JEL Classification: F32, E32