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Trade and Synchronization in a Multi Country Economy

Paulo Santos Monteiro () and Luciana Juvenal ()

No 59, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: Substantial evidence suggests that countries with stronger trade linkages have more synchronized business cycles. The standard international business cycle framework cannot replicate this finding, uncovering the trade-comovement puzzle. We show that under certain macro-level conditions but irrespective of the micro-level assumptions concerning trade the puzzle arises because trade fails to substantially increase the correlation between each country's import penetration ratio and the trade partner's technology shock. Within a large class of trade models, there are three channels through which bilateral trade may increase business cycle synchronization. Specifically, increased bilateral trade may (i) raise the correlation between each country's technology shocks, (ii) raise the correlation between each country's share of expenditure on domestic goods, and (iii) raise the response of the domestic import penetration ratio to foreign technology shocks. Empirical evidence strongly supports the first and second channels. We show that the trade-comovement puzzle can be resolved if productivity shocks are more correlated between country-pairs that trade more.

New Economics Papers: this item is included in nep-dge
Date: 2012
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Related works:
Journal Article: Trade and synchronization in a multi-country economy (2017) Downloads
Working Paper: Trade and Synchronization in a Multi-Country Economy (2010) Downloads
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