Trade balance and income in historical perspective

This paper develops a dynamic analysis of the trade balance to investigate the roles of supply and demand shocks. It also introduces global shocks in the analysis to take into account the comovement of income across countries. The results, based on the long-run historical data and a structural VAR analysis, show that, in the U.K., Australia, Canada, and Sweden, domestic and global supply shocks, while dominant causes in long-term and cyclical changes in output, are unimportant for the trade balance. The trade balance is explained mostly by shocks that cause transitory changes in income. Transitory income shocks cause income and the trade balance to move in opposite directions in all countries except Sweden. The countercyclical behavior of the trade balance seems to be a robust feature in the U.K. and Canada but not in the smaller economies of Australia and Sweden.