Working Paper: CEPR ID: DP7292
Authors: Sebnem Kalemli-Ozcan; Elias Papaioannou; Jos Luis Peydro-Alcalde
Abstract: Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.
Keywords: banks; business cycles; comovement; financial integration; financial regulation
JEL Codes: E32; F15; F36; G21; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial Integration (F30) | Business Cycle Synchronization (F44) |
| Banking Integration predicted by Legislative Harmonization Policies (F65) | Business Cycle Synchronization (F44) |
| Bilateral Exchange Rate Regime (F33) | GDP Fluctuations (F44) |