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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 has disappointed, to a much larger extent than global 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. Therefore, 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. We then analyze the implications of our findings for the cross-country differences in the elasticity, the role of long-run and cyclical factors for the recent weakness of trade, and the accuracy of existing trade forecasts, which we significantly improve by exploiting real-time data on business conditions.

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