The Global Financial Cycle and the Gravity of Finance and Trade

Cross-border finance matters for cross-border trade and, hence, the global financial conditions driven by a global financial cycle, in which the U.S. dollar’s nominal effective exchange rate plays a key role. Utilizing empirical gravity models for both trade and finance, we explore the relevance of cross-border loans for bilateral trade. We also detail how a global dollar cycle affects exports both directly and indirectly via a finance-trade channel. In line with the macroeconomic literature, we confirm that also on a bilateral level these effects are particularly strong if one trading partner is an emerging market or developing economy. By developing a finance-augmented trade gravity model, we are also shedding new light on the workings of classical gravity variables, such as physical distance and common borders, but also currency unions and regional trade agreements on the gravity of trade.