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The Cyclicality of the Income Elasticity of Trade

Borin, Alessandro and Di Nino, Virginia and Mancini, Michele and Sbracia, Massimo (2016): The Cyclicality of the Income Elasticity of Trade.

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In 2011-2015 global trade volumes have systematically surprised on the downside, to a much larger extent than real GDP. We show that two key features of real trade flows --- their high volatility and their procyclicality --- determine a cyclicality of the income elasticity of trade. This property is such that when real GDP growth is positive but lower than its long-run trend, then the income elasticity of trade is also smaller than its own long-run trend. As a consequence, when real GDP growth turns out to be weaker than expected, the forecast error on trade volumes is amplified by the fact that also the income elasticity of trade happens to be smaller than predicted. Our analysis shows, in particular, that long-run and cyclical forces have contributed to a similar extent to the recent weakness of trade volumes. As a by-product, we also explain how the high volatility and procyclicality of real trade flows, together with the size of the non-tradeable-goods sector, contribute to determine cross-country differences in the income elasticity of trade.

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