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Explaining international business cycle synchronization: Recursive preferences and the terms of trade channel

Robert Kollmann ()

CAMA Working Papers from Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University

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 commove 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)
New Economics Papers: this item is included in nep-opm and nep-upt
Date: 2017-03
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Related works:
Journal Article: Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (2019) Downloads
Working Paper: Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (2017) Downloads
Working Paper: Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (2017) Downloads
Working Paper: Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (2017) Downloads
Working Paper: Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (2017) Downloads
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