Growth prospects and the trade balance in advanced economies

Does an improvement in growth prospects lead to a fall in the trade balance? The answer in the literature with a strong focus on the U.S. economy is yes. 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. and Germany, news shocks induce a deterioration of the trade balance, in other G7 countries, news shocks have positive trade balance effects. The differences in the trade balance effects across the G7 countries are mainly due to heterogeneous reactions of exchange rates, labor markets, wealth effects, and monetary policy. Therefore, policy recommendations aimed at reducing the trade imbalances through productivity-enhancing reforms in advanced economies might not entail the targeted effects.