Time-Scale and the S-Curve: A Wavelet Analysis of Trade Dynamics

Abstract

This paper studies the dynamic structural relationship between the trade balance and the terms of trade by means of a time-scale decomposition. Our analysis is carried out using data obtained from ten developed economies; Australia, Austria, Canada, France, Italy, Japan, Norway, Switzerland, the United Kingdom and United States. In doing so, we make two substantive contributions to the literature. First, we perform Granger Causality tests in the spirit of Ramsey & Lampart (1998) to analyze the Harberger-Laursen-Metzler effect upon the international trade of goods and services for our economies of interest across different time scales. The results of these tests motivate a second, deeper empirical exploration into the underlying structural dynamic relationship of these two variables. Using wavelet analysis, we show that by employing a time scale decomposition of the data we are able to verify the presence of the S-curve predicted by Backus, Kehoe & Kydland (1994) by uncovering a far more precise depiction of the shape of the cross correlation function between the trade balance and the terms of trade. Through our findings we demonstrate that time scale decompositions can uncover features of economic phenomena that may be undetected by standard techniques.

Keywords: International Trade, Wavelet, S Curve, Terms of Trade, J Curve, Granger Causality, Trade Dynamics