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The Trade Comovement Puzzle and the Margins of International Trade

Author

Listed:
  • Wei Liao

    (Hong Kong Institute for Monetary Research)

  • Ana Maria Santacreu

    (INSEAD and Hong Kong Institute for Monetary Research)

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 the international diffusion of technology through trade in varieties may be driving the observed comovement by increasing the correlation of 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 third of total trade. We then develop a three-country model of technology innovation and international diffusion through trade, in which TFP correlation increases with trade in varieties. A numerical exercise shows that the proposed mechanism increases business cycle synchronization relative to traditional models. Impulse responses to a TFP shock in one country reveal a strong positive effect on the output of its trading partner. Finally, our model implies a trade-output coefficient that is 40% of that observed in the data and 5 times higher than that predicted by standard models.

Suggested Citation

  • Wei Liao & Ana Maria Santacreu, 2012. "The Trade Comovement Puzzle and the Margins of International Trade," Working Papers 042012, Hong Kong Institute for Monetary Research.
  • Handle: RePEc:hkm:wpaper:042012
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    References listed on IDEAS

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    Citations

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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, pages 82-108.
    2. Grüning, Patrick, 2015. "International endogenous growth, macro anomalies, and asset prices," SAFE Working Paper Series 83, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    3. Gavazzoni, Federico & Santacreu, Ana Maria, 2015. "International R&D Spillovers and Asset Prices," Working Papers 2015-41, Federal Reserve Bank of St. Louis.
    4. Francois de Soyres, 2016. "Trade and Interdependence in International Networks," 2016 Meeting Papers 157, Society for Economic Dynamics.
    5. Edouard Challe & Julien Matheron & Xavier Ragot & Juan F. Rubio‐Ramirez, 2017. "Precautionary saving and aggregate demand," Quantitative Economics, Econometric Society, vol. 8(2), pages 435-478, July.
    6. 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.
    7. Santacreu, Ana Maria, 2015. "Synchronization of Business Cycles and the Extensive Margin of Trade," Economic Synopses, Federal Reserve Bank of St. Louis, issue 15.
    8. Zlate, Andrei, 2016. "Offshore production and business cycle dynamics with heterogeneous firms," Journal of International Economics, Elsevier, pages 34-49.
    9. Stephen S. Poloz, 2016. "The Paul Storer Memorial Lecture—Cross-Border Trade Integration and Monetary Policy," Discussion Papers 16-20, Bank of Canada.
    10. Mine Senses & Andrei Zlate & Christopher Kurz, 2017. "All Shook Up: International Trade and Firm-level Volatility," 2017 Meeting Papers 851, Society for Economic Dynamics.

    More about this item

    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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