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Trade and Synchronization in a Multi-Country Economy

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JournalEuropean economic review
DateAccepted/In press - 17 Jun 2016
DateE-pub ahead of print - 22 Jun 2016
DatePublished (current) - Feb 2017
Volume92
Number of pages31
Pages (from-to)385–415
Early online date22/06/16
Original languageEnglish

Abstract

Countries with strong trade linkages have more synchronized business cycles. However, the standard international business cycle framework cannot replicate this finding, uncovering the trade-comovement puzzle. Modeling trade using more sophisticated micro-level assumptions does not help resolve the puzzle. This happens because for a large class of trade models, under certain macro-level conditions, output comovement is determined by the same factor structure. We show that in such models comovement can be explained by three factors: (i) the correlation between each country's TFP; (ii) the correlation between each country's share of expenditure on domestic goods; and (iii) the correlation between each country's TFP and the partner's share of expenditure on domestic goods. An empirical investigation of the link between trade and each of the three factors shows that the trade-comovement relation is in large part explained by the second factor while in the theoretical model this factor reacts counterfactually to changes in trade costs.

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    Research areas

  • Business Cycle Synchronization, International Trade

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