Trade, Growth, and the International Transmission of Financial Shocks

This study develops a two-country model to explore how financial shocks in one country affect its partner country's business cycles through international trade. Unlike existing studies, I introduce the mechanism of endogenous trade patterns, by which a shock can affect both the intensive and extensive margins of trade. I also embed the mechanism of endogenous growth into the model to indicate the potential for prolonged recessions, even for a transitory shock. I obtain the following four main findings. First, an adverse financial shock in one country induces a global recession, even in the absence of international financial transactions. Second, although the downward shift of real GDP in the partner country is not so large, it can be very prolonged. Third, the real value of exports in the partner drops more seriously than its real GDP. Finally, this drop is caused mainly by a change at the intensive margin rather than the extensive margin.