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The Impact of Financial Market Frictions on Trade Flows, Capital Flows and Economic Development

  • Spiros Bougheas
  • Rod Falvey

We document that, at business cycle frequencies, fluctuations in nominal variables, such as aggregate price levels and nominal interest rates, are substantially more synchronized across countries than fluctuations in real output. To the extent that domestic nominal variables are largely determined by domestic monetary policy, this might seem surprising. We ask if a parsimonious international business cycle model can account for this aspect of cross-country aggregate fluctuations. It can. Due to spillovers of technology shocks across countries, expected future responses of national central banks to fluctuations in domestic output and inflation generate movements in current prices and interest rates that are synchronized across countries even when output is not. Even modest spillovers produce cross-country correlations such as those in the data.

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File URL: http://www.nottingham.ac.uk/cfcm/documents/papers/11-03.pdf
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Paper provided by University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) in its series Discussion Papers with number 11/03.

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Handle: RePEc:not:notcfc:11/03
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