AGGREGATE SUPPLY,DOMESTIC ABSORPTION,AND TERMS OF TRADE: A STRUCTURAL DECOMPOSITION OF THE U.S. TRADE BALANCE

Using an intertemporal model as a reference, this article decomposes U.S. trade balance movements into parts driven by supply shocks, demand shocks, and relative price shocks. In identifying structural shocks, we propose a new type of long-run restriction that extends the previous structural Vector Autoregression (VAR) literature, and demonstrate its relationship to other identifying schemes. Empirical results indicate that relative price shocks and demand shocks are important in the short run while demand and supply shocks dominate in the long run in explaining the U.S. trade balance.