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

  • Michael R. Pakko

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.

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File URL: http://research.stlouisfed.org/wp/more/1997-023
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1997-023.

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Date of creation: 1997
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Handle: RePEc:fip:fedlwp:1997-023
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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the S-curve," Working Paper 9211, Federal Reserve Bank of Cleveland.
  2. King, R.G. & Rebelo, S.T., 1989. "Low Frequency Filtering And Real Business Cycles," RCER Working Papers 205, University of Rochester - Center for Economic Research (RCER).
  3. Michael R. Pakko, 1998. "Characterizing Cross-Country Consumption Correlations," The Review of Economics and Statistics, MIT Press, vol. 80(1), pages 169-174, February.
  4. Patrick J. Kehoe & Fabrizio Perri, 2002. "International Business Cycles with Endogenous Incomplete Markets," Econometrica, Econometric Society, vol. 70(3), pages 907-928, May.
  5. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987. "International real business cycles," Working Papers 426, Federal Reserve Bank of Minneapolis.
  6. Baxter, M. & Crucini, M., 1991. "Business Cycles and the Asset Structure of Foreign Trade," RCER Working Papers 316, University of Rochester - Center for Economic Research (RCER).
  7. Maurice Obstfeld, 1993. "Are Industrial-Country Consumption Risks Globally Diversified?," NBER Working Papers 4308, National Bureau of Economic Research, Inc.
  8. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  9. Cantor, Richard & Mark, Nelson C, 1988. "The International Transmission of Real Business Cycles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(3), pages 493-507, August.
  10. Alan C. Stockman & Linda L. Tesar, 1990. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc.
  11. Cole, Harold, 1988. "Financial Structure and International Trade," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 29(2), pages 237-59, May.
  12. Michael B. Devereux & Allan W. Gregory & Gregor W. Smith, 1990. "Realistic Cross-Country Consumption Correlations in a Two-Country, Equilibrium, Business Cycle Model," Working Papers 774, Queen's University, Department of Economics.
  13. Stockman, Alan C. & Dellas, Harris, 1989. "International portfolio nondiversification and exchange rate variability," Journal of International Economics, Elsevier, vol. 26(3-4), pages 271-289, May.
  14. 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.
  15. Backus, David K. & Crucini, Mario J., 2000. "Oil prices and the terms of trade," Journal of International Economics, Elsevier, vol. 50(1), pages 185-213, February.
  16. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers 1252, Queen's University, Department of Economics.
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