Working Paper: CEPR ID: DP3268
Authors: Jonathan Heathcote; Fabrizio Perri
Abstract: Over the period 1972-86, the correlations of GDP, employment and investment between the United States and an aggregate of Europe, Canada and Japan were respectively 0.76, 0.66 and 0.63. For the period 1986 to 2000 the same correlations were much lower: 0.26, 0.03, and -0.07 (real regionalization). At the same time, US international asset trade has significantly increased. For example, between 1972-99, United States gross FDI and equity assets in the same group of countries rose from 4 to 23% of the US capital stock (financial globalization). We document that the correlation of real shocks between the US and the rest of the world has declined. We then present a model in which international financial market integration occurs endogenously in response to less correlated shocks. Financial integration further reduces international correlations in GDP and factor supplies. We find that both less correlated shocks and endogenous financial market development are needed to account for all the changes in the international business cycle.
Keywords: International business cycles; International diversification
JEL Codes: F36; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial globalization (F65) | Reduced correlation in international business cycles (F44) |
| Less correlated shocks (E32) | Increased financial globalization (F65) |
| Less correlated shocks (E32) | Decline in correlation of real shocks between the US and the rest of the world (F69) |
| Increased financial globalization (F65) | Decline in correlations of GDP, employment, and investment between the US and Europe, Canada, and Japan (F69) |
| Increased international asset trade (F30) | Decline in correlation of real shocks between the US and the rest of the world (F69) |
| Less correlated shocks + Endogenous financial market development (G19) | Changes in the international business cycle (F44) |
| Decline in correlation of productivity shocks (O49) | Increase in equilibrium level of portfolio diversification (G19) |
| Decline in correlation of productivity shocks (O49) | Reduced international correlations in macroeconomic aggregates (F49) |