Economic Policy Uncertainty and International Trade: A Gravity Model Approach

Abstract Considering the increasing exposure of firms to global policy shocks, this paper study the bilateral trade adjustments to the increases in economic policy uncertainty (EPU) of 126 countries over the period 1996-2014. We employ a gravity model and a robust Poisson Pseudo Maximum Likelihood (PPML) estimator that mitigates the problem of heteroscedasticity and zero trade flows. The results show that large variations in bilateral trade can be explained by the changes in economic policy uncertainty. Whereas heightened EPU from partner countries has a positive spillover effect on imports to the reporting country, we find a negative and statistically significant effect of domestic EPU on exports.