Policy mix and the U.S. trade balance

• Author: Carolina Osorio Buitron,Gustavo Adler
• DOI: http://doi.org/10.1111/infi.12334
• Published date: 01 August 2019
• Date: 01 August 2019

DOI: 10.1111/infi.12334

ORIGINAL ARTICLE

Policy mix and the U.S. trade balance

Gustavo Adler

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Carolina Osorio Buitron

International Monetary Fund,

Washington, District of Columbia

Correspondence

Gustavo Adler, International Monetary

Fund, 700 19th Street NW, Washington,

District of Columbia, USA.

Email: gadler@imf.org

Abstract

The strong policy response of the United States to the

2008–2009 financial crisis raised concerns about its

spillovers on other countries. The effects of the monetary

stimulus received significant attention, while those of fiscal

policy were largely overlooked, despite the combined

deployment of these two policy instruments. This paper

studies the trade spillovers of the post-crisis policy mix. We

find that overall effects were positive in the immediate

aftermath of the crisis, reflecting positive spillovers of fiscal

policy that outweighed the negative impact of monetary

policy. More generally, our results highlight (i) the

importance of studying fiscal and monetary policy spill-

overs jointly, as models with both instruments produce very

different (and arguably more accurate) estimates of the

effects of fiscal and monetary policy shocks, and (ii) that

exchange rate regimes of trading partners are first-order

determinants of the extent of policy spillovers.

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INTRODUCTION

Confronted with an impending economic depression following the 2008–2009 financial crisis,

policymakers in many advanced economies deployed extraordinary policy measures to stimulate their

economies. The United States led the effort with the deployment of sizable fiscal and monetary policy

stimuli. Monetary policy rates were sharply lowered, rapidly reaching the zero lower bound (ZLB),

followed by the implementation of quantitative easing (QE) in its different phases (Figure 1, left

The views expressed in this paper are those of the authors and do not necessarily represent the views of the IMF, its

Executive Board, or IMF management.

The International Monetary Fund retains copyright and all other rights in the manuscript of this article as submitted for

publication.

International Finance. 2018;1–17. wileyonlinelibrary.com/journal/infi © 2018 John Wiley & Sons Ltd

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© 2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/infi International Finance. 2019;22:138–154.

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panel).

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Extraordinary monetary easing was complemented with the deployment of expansionary fiscal

policy, beyond the effect of automatic stabilizers, as apparent in the near 8 percentage points of GDP

weakening of the fiscal balance between 2007 and 2009 (Figure 1, right panel).

The implementation of these aggressive policy measures quickly raised questions about their

implications for the U.S. external position as well as the impact on its trading partners (i.e. spillovers).

Policymakers of emerging-market economies, in particular, voiced concerns about the effect of aggressive

monetary loosening—and the resulting depreciation of the U.S. dollar—on their economies, starting from

the premise that such policies entailed large demand-diverting effects to the detriment of trading partners.

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The controversy surrounding the effects of aggressive monetary easing reached its climax with the

implementation of quantitative easing (QE), as this was seen to be particularly damaging to trading partners,

and led to the perception that there was an ongoing ‘currency war’—an expression coined by Brazil's

Finance Minister Guido Mantega in a speech delivered in September 2010.

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Concerns grew over time, as

many believed the United States (and other advanced economies) had relied excessively on loose monetary

policy—partly because of fiscal constraints imposed by high public debt levels in some countries—and had

propped up its economy at the expense of its trading partners. The marked improvement in the U.S. trade

balance in the initial aftermath of the crisis lent support to such a view (Figure 2).

A flurry of academic and policy work followed, focusing almost exclusively on the role of

(unconventional) monetary policy and its effects on trading partners. Surprisingly, however, the effects

of fiscal policy received very limited attention, despite the fact that these two policy instruments were

deployed jointly to mitigate the impact of the financial crisis. As a result, most of the analysis that

followed not only provided a partial view of the role of policies during the crisis but, more importantly,

may have led to inaccurate conclusions about the effects of monetary policy by incurring an omitted-

variable bias due to its focus on individual policies rather than on the policy mix.

This paper revisits this issue, studying the joint impact of both U.S. fiscal and monetary policy

shocks on its trade balance.

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The methodological approach follows the work by Ehrmann, Fratzscher,

and Rigobon (2011), Matheson and Stavrev (2014), and Mountford and Uhlig (2009), who identify

policy shocks within a sign-restricted structural VAR model by exploiting the distinct effect that

structural monetary and fiscal policy shocks have on key asset prices (bonds, stocks, and the exchange

rate). This methodology provides an alternative to the so-called narrative approach—explored, for

example, by Kuttner (2001) and Romer and Romer (2004) for the case of monetary policy shocks; and

FIGURE 1 U.S. interest rates and fiscal balance, 1990–2016

Sources: Haver Analytics, IMF International Financial Statistics; and authors’ calculations

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