Dynamics of bilateral trade under economic policy uncertainty

Abstract

This study investigates the impact of economic policy uncertainty (EPU) on bilateral trade using a modified gravity model of Anderson and van Wincoop (2003) for 21 economies from 2003 to 2018. The analysis includes the yearly mean and standard deviation of EPUs to assess the effects of EPU levels and volatilities on trade values. Increased domestic EPU significantly reduces imports and total trade, while increased partner EPU decreases exports but increases imports. EPU volatility in both domestic and partner countries significantly reduces bilateral trade values. These findings suggest that countries turn to foreign markets to offset domestic demand decreases due to high EPU, except when EPU volatility is high, which negatively impacts all trade activities. The study emphasizes the need for stable, transparent, and rules-based policy frameworks to sustain global trade growth.