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The High Cross-Country Correlations of Prices and Interest Rates

  • Henriksen, Espen
  • Kydland, Finn
  • Sustek, Roman

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 determined by domestic monetary policy, and central banks generally attempt to keep the domestic nominal environment stable, 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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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 10963.

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Date of creation: 12 Sep 2008
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Handle: RePEc:pra:mprapa:10963
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