Government spending, the balance of trade and the terms of trade in British history

Abstract

This paper investigates the relationship between government spending, the balance of trade and the terms of trade using early British data. A large open-economy intertemporal framework, in which Ricardian equivalence holds, predicts a larger effect of temporary government spending changes on the trade deficit than permanent ones. Further, a pure switch between debt and taxes should have no effect on trade flows. The results provide some support for these hypotheses, although they are sensitive to sample period and the method of decomposition of government spending. A negative relationship between government spending and the terms of trade is also found.