Policy Uncertainty and the Margins of Trade

Abstract

Building upon recent theoretical models in international trade, we derive predictions for the impact of policy uncertainty on the margins of trade. We decompose aggregate bilateral trade ows from 1995-2012 into intensive and extensive margin components and employ a standard gravity specication to assess the impact of policy uncertainty on each margin separately. Consistent with the model, increases in policy uncertainty decrease both trade values and the extensive margin but have an ambiguous eect on the intensive margin. After controlling for various measures of expected future economic conditions, our estimates indicate that a 10% increase in policy uncertainty would lead to a 1% decrease in aggregate trade ows, with virtually all of the decline attributable to the extensive margin. In further tests we nd that our results cannot be attributed solely to the recent global economic crisis or to periods with extremely high levels of policy-related uncertainty.