Pricing-to-market and business cycle synchronization

Luciana Juvenal and Paulo Santos Monteiro

No 2010-038, Working Papers from Federal Reserve Bank of St. Louis

Abstract: There is substantial evidence that countries or regions with stronger trade linkages tend to have business cycles which are more synchronized. However, the standard international business cycle framework cannot replicate this finding. In this paper we study a multiple- country model of international trade with imperfect competition and variable markups and embed it into a real business cycle framework by including aggregate technology shocks and allowing for variable labor supply. The model is successful at replicating the empirical relation between trade and business cycle synchronization. High trade costs increase the real exchange rate volatility because firms choose to price-to-market and this volatility decouples countries' business cycle fluctuations. We find empirical evidence supporting this mechanism.

Keywords: International trade; Business cycles (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-bec, nep-cba, nep-dge, nep-int, nep-mac and nep-opm
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