Are the fiscal and monetary policies of the G-7 countries effective in decreasing the U.S. trade deficit?

Abstract

The U.S. trade deficit is a major concern for the G-7 countries. However, it is unclear whether their fiscal and monetary policies are effective in this regard. We examine the relationship between the U.S. trade balance and the G-7 countriesÂf policy variables by constructing an eight-dimensional version of the structural vector autoregression (SVAR) model. Our empirical results suggest that a reduction in the U.S. fiscal deficit is not such a reliable instrument for reducing the U.S. trade imbalance. Contrastingly, monetary tightening in the U.S. can reduce its trade deficit. Non-U.S. policy shocks are ineffective, while decline in the U.S. dollar plays an important role in reducing the U.S. trade deficit.