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Factor Proportions and International Business Cycles

  • Keyu Jin
  • Nan Li

Positive investment comovements across OECD economies as observed in the data are difficult to replicate in open-economy real business cycle models, but also vary substantially in degree for individual country-pairs. This paper shows that a two-country stochastic growth model that distinguishes sectors by factor intensity (capital-intensive vs. labor-intensive) gives rise to an endogenous channel of the international transmission of shocks that first, can substantially ameliorate the "quantity anomalies" that mark large open-economy models, and second, generate a cross-sectional prediction that is strongly supported by the data: investment correlations tend to be stronger for country-pairs that exhibit greater disparity in the factor-intensity of trade. In addition, three new pieces of evidence support the central mechanism: (1) the production composition of capital versus labor-intensive sectors changes over the business cycle; (2) the prices of capital-intensive goods and labor-intensive goods are respectively, procyclical and countercyclical; (3) a positive productivity shock in the U.S. tilts the composition of production towards capital-intensive sectors in other countries.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1090.

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Date of creation: Nov 2011
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Handle: RePEc:cep:cepdps:dp1090
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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