Does Credit Market Integration Amplify the Transmission of Real Business Cycle During Financial Crisis?

This study explores the role of cross-border (short-term and long-term) debt holdings in the transmission of the crisis shock to international real business cycle. We first provide a simple two-country DSGE model which distinguishes two transmission channels of real business cycle in credit markets: i) balance sheet effect operating in the short-term debt market owing to roll-over risk and ii) efficient allocation of investment working through the long-term debt market. Consistent with the model’s prediction, our empirical analysis using country-pair data for 57 countries during 2001–2013 shows the heterogeneous roles of short-term and long-term debt integration during financial crises. Short-term debt integration among developed countries drives the results of business cycle synchronization during the crises, whereas long term debt holdings by emerging and developing countries cushioned the transmission of the real business cycle.