Off the cliff and back? Credit conditions and international trade during the global financial crisis

Abstract

We examine the collapse of international trade flows during the 2008-2009 global financial crisis using detailed data on the evolution of monthly U.S. imports over the November 2006 - April 2009 period. We show that credit constraints and the reduction in the availability of external capital were an important channel through which the crisis affected trade volumes. We identify the effects of credit tightening by exploiting the variation in the cost of capital across countries and over time, as well as the variation in financial dependence across sectors. We find that countries with higher interbank interest rates and thus tighter credit markets export less in every period and are hit harder by the crisis. These effects are especially pronounced in sectors that require extensive external financing, have few collateralizable assets, and can access limited trade credit. Exports of financially vulnerable industries are thus more sensitive to the cost of external capital than exports of less dependent industries, and this sensitivity rises during the financial crisis. Our findings imply that the crisis would have reduced trade flows by 26% more if governments had not acted to lower interest rates, and by 30% less if policy interventions had had a more immediate effect on the cost of capital. These results provide new evidence on the causal effect of credit constraints on trade, and highlight the large real effects of financial market disturbances, the substantial cost of crisis contagion across countries, and the potential welfare gains of policy intervention.