The High Correlations of Prices and Interest Rates across Nations

Roman Sustek, Finn Kydland and Espen Henriksen
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Roman Sustek: Bank of England
Finn Kydland: University of California--Santa Barbara

No 773, 2008 Meeting Papers from Society for Economic Dynamics

Abstract: We document that at business cycle frequency, nominal variables, such as aggregate price levels and nominal interest rates, are more correlated across countries than real output. Since national central banks control the domestic money supply and their objective has been to keep the nominal environment stable this might seem puzzling. We ask whether a simple, transparent standard international business cycle model can account for these nominal as well as the real aspects of international business cycles. It can. Due to spillovers of technology shocks across countries, responses of national central banks to fluctuations in domestic output and inflation generate responses of prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce correlations like those in the data.

Date: 2008
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Related works:
Working Paper: The High Cross-Country Correlations of Prices and Interest Rates (2011)
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