Do changes in credit availability lead to short-run deviations from the long-run growth rate of trade? Evidence from the U.S.

Abstract

Recently, industrialized countries experienced tight financial conditions to an extent that has been unprecedented for decades. This coincided with an implosion of world trade. Is this mere coincidental or is this a result? More generally, can short-term deviations from the long-term growth rate of trade be explained by changes in the availability of external finance? Based on a 14 year sample, the answer seems to be yes. Using an error correction model, quarterly data of the U.S. was analyzed for the period 1991:4 - 2005:4. Over 70 percent of the variance in trade was explained, using income, vertical specialization, technological development and tariff rates as long-run drivers of trade, while changes in credit standards allowed for short-run deviations in the trade growth rate. Estimators of these credit standards were statistically and economically significant, and largely robust to several model specifications. Furthermore, this study finds support for the proposition that inventory investments are reduced to accommodate for credit contractions, thus reducing trade volume. Also, this paper provides a first glance on how effects of financial stress may differ for an industrialized compared to an emerging market.