Understanding the international great moderation

Vincenzo Quadrini and Fabrizio Perri

No 1057, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: The majority of OECD countries has experienced a reduction in macroeconomic volatility during the last two decades. This period is also characterized by a gradual liberalization of the capital accounts in these countries. We first show that, on average, countries/periods with more open capital markets are associated with lower macroeconomic volatility. Second we provide a theory of why capital account liberalization can lead to less macroeconomic volatility. In a simple open economy setting we study the impact of more open capital markets on the transmission and the amplification of two types of shocks: financial and real. We find that, in any given country, greater international integration substantially reduces the amplification of financial shocks; we also find that this channel can quantitatively affect business cycles dynamics. Our findings suggest that up to 1/3 of the worldwide reduction in business cycle volatility can be explained by greater international financial integration.

Date: 2008
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