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The Trade Comovement Puzzle and the Margins of International Trade

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  • Wei Liao
  • Ana Maria Santacreu

Abstract

Countries that trade more with each other tend to have more correlated business cycles. Yet, traditional international business cycle models predict a much weaker link between trade and business cycle comovement. We propose that fluctuations in the number of varieties embedded in trade flows may drive the observed comovement by increasing the correlation among trading partners? total factor productivity (TFP). Our hypothesis is that business cycles should be more correlated between countries that trade a wider variety of goods. We find empirical support for this hypothesis. After decomposing trade into its extensive and intensive margins, we find that the extensive margin explains most of the trade?TFP and trade?output comovement. This result is striking because the extensive margin accounts for only a fourth of the variability in total trade. We then develop a two-country model with heterogeneous firms, endogenous entry, and fixed export costs, in which TFP correlation increases with trade in varieties. A numerical exercise shows that our proposed mechanism increases business cycle synchronization compared with the levels predicted by traditional models.

Suggested Citation

  • Wei Liao & Ana Maria Santacreu, 2014. "The Trade Comovement Puzzle and the Margins of International Trade," Working Papers 2014-43, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2014-043
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    Cited by:

    1. Julian di Giovanni & Andrei A. Levchenko & Isabelle Mejean, 2018. "The Micro Origins of International Business-Cycle Comovement," American Economic Review, American Economic Association, vol. 108(1), pages 82-108, January.
    2. Barthélémy Bonadio & Zhen Huo & Andrei A. Levchenko & Nitya Pandalai-Nayar, 2020. "Global Supply Chains in the Pandemic," NBER Working Papers 27224, National Bureau of Economic Research, Inc.
    3. Grüning, Patrick, 2018. "Heterogeneity in the internationalization of R&D: Implications for anomalies in finance and macroeconomics," Finance Research Letters, Elsevier, vol. 26(C), pages 132-138.
    4. Juvenal, Luciana & Santos Monteiro, Paulo, 2017. "Trade and synchronization in a multi-country economy," European Economic Review, Elsevier, vol. 92(C), pages 385-415.
    5. Grüning, Patrick, 2017. "International endogenous growth, macro anomalies, and asset prices," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 118-148.
    6. di Giovanni, Julian & Levchenko, Andrei A. & Mejean, Isabelle, 2020. "Foreign Shocks as Granular Fluctuations," CEPR Discussion Papers 15458, C.E.P.R. Discussion Papers.
    7. Ana Maria Santacreu & Federico Gavazzoni, 2015. "International R&D Spillovers and Asset Prices," 2015 Meeting Papers 405, Society for Economic Dynamics.
    8. de Soyres, Francois & Gaillard, Alexandre, 2020. "Global Trade and GDP Co-Movement," MPRA Paper 100518, University Library of Munich, Germany.
    9. Francois de Soyres, 2016. "Trade and Interdependence in International Networks," 2016 Meeting Papers 157, Society for Economic Dynamics.
    10. Michael Donadelli, 2013. "Global integration and emerging stock market excess returns," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 6(2), pages 244-279, September.
    11. Ana Maria Santacreu, 2015. "Synchronization of Business Cycles and the Extensive Margin of Trade," Economic Synopses, Federal Reserve Bank of St. Louis, issue 15.
    12. Zlate, Andrei, 2016. "Offshore production and business cycle dynamics with heterogeneous firms," Journal of International Economics, Elsevier, vol. 100(C), pages 34-49.
    13. Stephen S. Poloz, 2016. "The Paul Storer Memorial Lecture—Cross-Border Trade Integration and Monetary Policy," Discussion Papers 16-20, Bank of Canada.
    14. Miyamoto, Wataru & Nguyen, Thuy Lan, 2019. "International Linkages and the Changing Nature of International Business Cycles," CEI Working Paper Series 2018-16, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    15. Dudley Cooke, 2019. "Technology Choice and the Long- and Short-Run Armington Elasticity," Globalization Institute Working Papers 373, Federal Reserve Bank of Dallas.
    16. Mine Senses & Andrei Zlate & Christopher Kurz, 2017. "All Shook Up: International Trade and Firm-level Volatility," 2017 Meeting Papers 851, Society for Economic Dynamics.
    17. Gunnella, Vanessa & Al-Haschimi, Alexander & Benkovskis, Konstantins & Chiacchio, Francesco & de Soyres, François & Di Lupidio, Benedetta & Fidora, Michael & Franco-Bedoya, Sebastian & Frohm, Erik & G, 2019. "The impact of global value chains on the euro area economy," Occasional Paper Series 221, European Central Bank.
    18. François de Soyres, 2016. "Value Added and Productivity Linkages Across Countries," Working Papers 209, Oesterreichische Nationalbank (Austrian Central Bank).
    19. Marco Pangallo, 2020. "Synchronization of endogenous business cycles," Papers 2002.06555, arXiv.org.

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    More about this item

    Keywords

    international business cycle comovement; TFP; extensive margin of trade.;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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