Trade and uncertainty

We offer a new explanation as to why international trade is so volatile in response to economic shocks. Our approach combines the idea of uncertainty shocks with international trade. In an open economy framework, firms order inputs from home and foreign suppliers, but with higher costs in the latter case. Due to fixed costs of ordering firms hold an inventory of inputs. In response to an uncertainty shock firms optimally adjust their inventory by cutting orders of foreign inputs disproportionately strongly. In the aggregate, this leads to a bigger contraction in international trade flows than in domestic activity, a magnification effect. We confront the model with newly-compiled U.S. import data and industrial production data going back to 1962, and also with disaggregated data at the industry level back to 1989. Our results suggest a tight link between uncertainty and fluctuations in international trade