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Sectoral interdependence and business cycle synchronization in small open economies

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Abstract

Existing DSGE models are not able to reproduce the observed influence of international business cycles on small open economies. We construct a two-sector New Keynesian model to address this puzzle. The set-up takes into account intermediate trade and producer heterogeneity, where goods and service industries differ in terms of i) price flexibility, ii) trade intensity, iii) technology, iv) I-O structure, and v) the volatility of productivity innovations. The combination of intermediate markets and heterogeneous producers makes international business cycles highly important for the small economy, even if it has a large service sector. Exploiting I-O matrices of Canadian and US industries, the model is able to reproduce the role of international disturbances typically found in empirical studies. Model simulations deliver cross-country correlations in macroeconomic variables of about 0:7, with half of the variation in domestic variables attributed to foreign shocks.

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  • Drago Bergholt & Tommy Sveen, 2014. "Sectoral interdependence and business cycle synchronization in small open economies," Working Paper 2014/04, Norges Bank.
  • Handle: RePEc:bno:worpap:2014_04
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    Cited by:

    1. Drago Bergholt, 2014. "Monetary Policy in Oil Exporting Economies," Working Papers No 5/2014, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
    2. Drago Bergholt, 2015. "Foreign Shocks," Working Papers No 11/2015, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.
    3. Lahiri, Kajal & Zhao, Yongchen, 2019. "International propagation of shocks: A dynamic factor model using survey forecasts," International Journal of Forecasting, Elsevier, vol. 35(3), pages 929-947.
    4. Hilde C. Bjørnland & Leif Anders Thorsrud & Sepideh Khayati Zahiri, 2016. "Do central banks respond timely to developments in the global economy?," Working Paper 2016/19, Norges Bank.
    5. Meenagh, David & Minford, Patrick & Oyekola, Olayinka, 2015. "Energy Business Cycles," Cardiff Economics Working Papers E2015/19, Cardiff University, Cardiff Business School, Economics Section.
    6. Drago Bergholt, 2014. "Foreign shocks in an estimated multi-sector model," Working Papers No 4/2014, Centre for Applied Macro- and Petroleum economics (CAMP), BI Norwegian Business School.

    More about this item

    Keywords

    Small open economy; Multi-sector; Intermediate trade; International business cycles.;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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