Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel

Kollmann, Robert

Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel

Open Economies Review, 2019, vol. 30, issue 1, No 3, 65-85

Abstract: Abstract The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded-good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively.

Keywords: International business cycle synchronization; Recursive preferences; Terms of trade; Real exchange rate; Wealth effect on labor supply (search for similar items in EconPapers)
JEL-codes: F31 F32 F36 F41 F43 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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DOI: 10.1007/s11079-018-9515-y

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