Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel

Kollmann, Robert (2017): Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel.

Abstract

The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded-good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks.Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively.

• Item Type: MPRA Paper
• Language: English
• Keywords: international business cycle synchronization, recursive preferences, terms of trade, real exchange rate, wealth effect on labor supply
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F32 - Current Account Adjustment ; Short-Term Capital Movements; F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F43 - Economic Growth of Open Economies; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F44 - International Business Cycles; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F47 - Forecasting and Simulation: Models and Applications

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