Looking at the components of trade may help illuminate the economic channels through which policy uncertainty affects trade. In principle, there are at least four channels. First, EPU could lead to precautionary cuts in all consumer spending, which would be reflected immediately in lower consumer goods imports. Second, EPU can reduce the incentives for foreign firms to invest in enhancing capacity to serve the market. We would expect a negative impact on imports across all sectors with a lag.<sup>5</sup> Third, EPU could erode the incentives for domestic firms to invest in general. Apart from the effect of these choices on future prices and trade (see Handley and Limao, 2016), the reduced investment could lead immediately to lower imports of capital goods. Fourth, EPU could hurt GVC participation by dampening domestic firms’ incentives to invest in relationships with foreign input suppliers, and eventually source less inputs from abroad.

The available evidence supports relatively strongly the first and the second channels, though it is not easy to isolate their separate effects (Table 3). The instantaneous effect on consumer spending is revealed in row 1, column 1. That these effects on consumer spending encompass non-durable goods only, and persist over time, is shown in row 5. The lagged effect on imports may reflect the shrunken capacity of foreign firms to serve the domestic market, but it could also reflect persistent dampening of domestic consumer spending. There is some support for the third and fourth channels. While investment in transport equipment does not seem to be affected at all (row 3), investment in other capital goods appears to be affected gradually but significantly (row 2). Finally, there are also signs of a gradual negative impact on GVC trade, measured by imports used to produce exports, suggesting that GVCs are sensitive to EPU (row 6).

**Table 3.** **_Coefficients of economic policy uncertainty in various specifications using yearly data_**

|||<br>A. R|l f EPU<br>elative prices:|l f EPU<br>REER|B. Relativ<br>defl|l f EPU<br>e prices: ratio<br>ator to GDP de|l f EPU<br>of import<br>flator|
|---|---|---|---|---|---|---|---|
||Dependent variable:<br>growth in the import volume of|log of EPU<br>index<br> <br>|og o<br>index ‐ lagged<br>2 months|<br>og o<br>index ‐ lagged<br>6 months|log of EPU<br>index|og o<br>index ‐ lagged<br>2 months|<br>og o<br>index ‐ lagged<br>6 months|
|(1)|Goods|‐0.0228**|‐0.0248**|‐0.0179**|‐0.0270**|‐0.0279**|‐0.0187**|
|(2)|Capital goods (excl. transport equipment)|‐0.0430*|‐0.0497**|‐0.0389*|‐0.0465*|‐0.0516**|‐0.0385*|
|(3)|Capital goods (transp.equipment)|‐0.0318|‐0.0278|‐0.0394|‐0.0402|‐0.0296|‐0.0369|
|(4)|Durable consumer goods|‐0.00777|‐0.0150|‐0.0136|‐0.0170|‐0.0217|‐0.0156|
|(5)|Non‐durable consumer goods|‐0.0258*|‐0.0309**|‐0.0225**|‐0.0359**|‐0.0397***|‐0.0277**|
|(6)|Backward GVC participation (intermediate goods<br>and services embodied in exports)|‐0.0244|‐0.0386**|‐0.0398*|‐0.0228|‐0.0370*|‐0.0381|

_Sources_ : International Monetary Fund World Economic Outlook, World Bank Global Economic Monitor, International Monetary Fund International Financial Statistics, World Trade Organization, World Input Output Database (WIOD), <u>www.PolicyUncertainty.com,</u> Baker et al. (2016), and authors’ calculations. See Table 1 for details. Notes: Heteroscedasticityrobust standard errors corrected for clustering at country level. * p<0.10; ** p<0.05; *** p<0.01. Panel covers 18 countries. Period

> 5 The intensity of impact may, of course, differ across sectors depending on the importance of up‐front investments, but we have little data on these differences.

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