US trade deficit, a reality check: New evidence incorporating asymmetric and non‐linear effects of exchange rate dynamics

Muhammad Ali Nasir,Mary Leung

doi:10.1111/twec.12986

Abstract

AbstractIn the context of the debate on the global imbalances, this study investigates the determinants of US trade balance in a non‐linear ARDL framework, which accounts for the asymmetric and non‐linear effects of real effective exchange rate dynamics. Drawing on the data from 1994Q1 to 2018Q1, our key empirical findings suggest significant evidence of short‐ and long‐run asymmetries in the relationship between the real effective exchange rate, US trade balance and its determinants. An asymmetric cumulative dynamic multiplier analysis shows evidence of an asymmetric J‐curve. Furthermore, we find that the price stability, productivity, domestic savings and fiscal deficit/discipline are crucial for the US trade balance in the short to long term. Empirical findings of this study contribute to the contemporary debate on the US trade deficit and have profound policy implications for the competitiveness of the US economy and its external balance.

Highlights

The “global imbalances”, a term often synonymously used for “current account imbalances”, are central to the policy debates on the global political and economic forums (Borio, 2016)
The impact of macroeconomic factors that influence the trade balance adjustment is complicated and interrelated. Keeping this debate in context, we investigated the determinants of US trade balance in a framework, which does account for the asymmetric and non-linear effects of exchange rate dynamics for the US trade balance
The depreciation can be beneficial to the US trade balance, which implies that the US trade deficit is related to the exchange rate pass-through to which the US has more influence

Summary

Introduction

The “global imbalances”, a term often synonymously used for “current account imbalances”, are central to the policy debates on the global political and economic forums (Borio, 2016). In this regard, the dynamics of the world's largest economy of the US with its gigantic trade volume has significant economic and political implications for the rest of the world. A prima facie manifestation of US trade balance dynamics is depicted, which shows persistent and widening deficit since the early 1990s. This has caused a heated debate and, most recently, a trade war

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