Inter-industry trade and business cycle dynamics

Motivated by the increased importance of trade between industrialized and less-developed countries, we build a two-sector dynamic stochastic general equilibrium model featuring inter-industry trade as well as intra-industry trade to analyze the business cycle dynamics of industrialized countries. We find that import-competing sectors are more sensitive to domestic productivity shocks than exporting sectors, due to their stronger reliance on domestic demand. This generates pressure to adjust relative prices and to reallocate factors of production. It also propagates the international spillover effects of productivity shocks leading to stronger business cycle comovement across countries, relative to a traditional business cycle model that does not feature inter-industry trade.