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Trade, investment, and international borrowing in two-country business cycle models

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  • Michael R. Pakko

Abstract

Two country applications of equilibrium business cycle methodology have succeeded in matching some key features of international fluctuations. However, discrepancies between theory and data remain. This paper identifies a new anomaly related to a basic property of typical models: the prediction of countercyclical net exports is fundamentally related to (counterfactual) implication for negative cross-country investment correlations. Although the introduction of investment adjustment costs can reverse this anomaly, it has the side-effect of inducing the wrong cyclical behavior for net exports. Possible resolutions to this puzzle are considered, including asset market restrictions and the role of the substitution elasticities.

Suggested Citation

  • Michael R. Pakko, 1997. "Trade, investment, and international borrowing in two-country business cycle models," Working Papers 1997-023, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:1997-023
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    References listed on IDEAS

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    2. Devereux, Michael B. & Gregory, Allan W. & Smith, Gregor W., 1992. "Realistic cross-country consumption correlations in a two-country, equilibrium, business cycle model," Journal of International Money and Finance, Elsevier, vol. 11(1), pages 3-16, February.
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    5. Feeney, JoAnne & Jones, Ronald W, 1994. "Risk Aversion and International Markets: Does Asset Trade Smooth Real Income?," Review of International Economics, Wiley Blackwell, vol. 2(1), pages 13-26, February.
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