The income and terms of trade effects: a permanent versus transitory decomposition in US trade

This paper develops an empirical analysis of the US trade balance with particular attention to the distinction between permanent and transitory disturbances to income and the terms of trade arising from real/monetary and demand/supply shocks. The results indicate that the income effects on the trade balance differ remarkably depending on whether a given change is permanent or transitory. For instance, a permanent increase in income deteriorates the trade balance whereas a transitory increase improves it. The results are contrasted to the predictions of the Mundell-Fleming-Dornbusch model and intertemporal models. (JEL F32).