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Trade and Synchronization in a Multi Country Economy

  • Paulo Santos Monteiro

    (University of Warwick)

  • Luciana Juvenal

    (Federal Reserve Bank of St Louis)

Substantial evidence suggests that countries with stronger trade linkages have more synchronized business cycles. The standard international business cycle framework cannot replicate this finding, uncovering the trade-comovement puzzle. We show that under certain macro-level conditions but irrespective of the micro-level assumptions concerning trade the puzzle arises because trade fails to substantially increase the correlation between each country's import penetration ratio and the trade partner's technology shock. Within a large class of trade models, there are three channels through which bilateral trade may increase business cycle synchronization. Specifically, increased bilateral trade may (i) raise the correlation between each country's technology shocks, (ii) raise the correlation between each country's share of expenditure on domestic goods, and (iii) raise the response of the domestic import penetration ratio to foreign technology shocks. Empirical evidence strongly supports the first and second channels. We show that the trade-comovement puzzle can be resolved if productivity shocks are more correlated between country-pairs that trade more.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 59.

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Date of creation: 2012
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Handle: RePEc:red:sed012:59
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the S-curve," Working Paper 9211, Federal Reserve Bank of Cleveland.
  2. César Calderón & Alberto E. Chong & Ernesto H. Stein, 2003. "Trade Intensity and Business Cycle Synchronization: Are Developing Countries any Different?," IDB Publications (Working Papers) 6501, Inter-American Development Bank.
  3. Hirokazu Ishise, 2011. "The World Has More Than Two Countries: Implications of Multi- Country International Real Business Cycle Models," IMES Discussion Paper Series 11-E-11, Institute for Monetary and Economic Studies, Bank of Japan.
  4. James Heckman & Edward Vytlacil, 1998. "Instrumental Variables Methods for the Correlated Random Coefficient Model: Estimating the Average Rate of Return to Schooling When the Return is Correlated with Schooling," Journal of Human Resources, University of Wisconsin Press, vol. 33(4), pages 974-987.
  5. Jean Imbs, 2004. "Trade, Finance, Specialization and Synchronization," Post-Print hal-00612588, HAL.
  6. M. Ayhan Kose & Kei-Mu Yi, 2001. "International Trade and Business Cycles: Is Vertical Specialization the Missing Link?," American Economic Review, American Economic Association, vol. 91(2), pages 371-375, May.
  7. Christian Zimmermann, 1995. "International Real Business Cycles among Heterogeneous Countries," Cahiers de recherche CREFE / CREFE Working Papers 38, CREFE, Université du Québec à Montréal.
  8. James E. Anderson & Eric van Wincoop, 2001. "Gravity with Gravitas: A Solution to the Border Puzzle," NBER Working Papers 8079, National Bureau of Economic Research, Inc.
  9. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
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