Working Paper: CEPR ID: DP9487
Authors: Philippe Bacchetta; Eric van Wincoop
Abstract: While the 2008-2009 financial crisis originated in the United States, we witnessed steep declines in output, consumption and investment of similar magnitudes around the globe. This raises two questions. First, given the observed strong home bias in goods and financial markets, what can account for the remarkable global business cycle synchronicity during this period? Second, what can explain the difference relative to previous recessions, where we witnessed far weaker co-movement? To address these questions, we develop a two-country model that allows for self-fulfilling business cycle panics. We show that a business cycle panic will necessarily be synchronized across countries as long as there is a minimum level of economic integration. Moreover, we show that several factors generated particular vulnerability to such a global panic in 2008: tight credit, the zero lower bound, unresponsive fiscal policy and increased economic integration.
Keywords: Contagion; Great Recession; International Comovements
JEL Codes: E32; F40; F41; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic integration (F15) | synchronized business cycle panic (E32) |
| synchronized business cycle panic (E32) | declines in output, consumption, and investment (E20) |
| tight credit conditions, zero lower bound on interest rates, unresponsive fiscal policy, increased economic integration (F65) | significant drop in expected future income (J17) |
| significant drop in expected future income (J17) | lowered current consumption and investment (E20) |
| economic integration (F15) | global panic (H12) |