Dissecting Trade and Business Cycle Co-movement

International business cycles have become highly synchronized across countries in the past three decades, yet there is a lack of consensus on whether this is due to an increase in the correlation of country-specific shocks or due to increased economic integration. To understand this empirical phenomenon, I develop a multi-country real business cycle model with international trade that captures several potential explanations: shocks to productivity, demand, leisure, investment, sectoral expenditures, and trade- linkages. By matching the data exactly with the endogenous outcomes of the model, shocks fully account for the data such as GDP and trade shares. Calibrating the model to a panel of developed (G7) countries during 1992-2014, I find that trade-linkage shocks, which capture the increased economic integration and volatility of trade flows, are essential in synchronizing international business cycles. In contrast, other correlated country-specific shocks play relatively minor roles. This suggests that trade shocks through economic integration have been the primary driver of the co-movement of international business cycles. Furthermore, I use my model to address the trade co-movement puzzle, which states that international real business cycle models should be predicting a much stronger link between trade and cross-country GDP correlations. Once I account for the trade-linkage shocks, the model predicts a strong link between trade and business cycle co-movement. This finding suggests that incorporating the dynamics of trade shocks is crucial when studying international business cycles.