Macroeconomic Shocks and Trade Balance Adjustments in Papua New Guinea

Abstract

Previous studies have mostly focused on the relationship between macroeconomic shocks and trade balance adjustments of resource-rich countries while largely overlooked countries with trade composition of high resource-export and strong import-dependence such as Papua New Guinea. Utilising a Bayesian Vector Autoregressive (BVAR) model, we quantify the relative importance of macroeconomic shocks on the country’s trade balance adjustments and examine how they evolve over time. Our identification strategy takes advantage of the fact that shocks generated from the resource sector and non-resource sector would have heterogeneous impacts on trade activity. We document that at a different point in time, all identified shocks except inflation contributed significantly to the fluctuations in trade balance with varying magnitude. The impulse responses show that one standard deviation of devaluation in the real exchange rate and resource boom lead to an immediate improvement in the trade balance. Shocks in the non-resource sector and inflation are found to have a positive impact on the trade balance, but they are mostly statistically insignificant.

Keywords: Bayesian VAR, trade balance, resource-rich developing countries, import-dependent, Papua New Guinea

JEL Classification: F31, F32, F14, F41