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Open Economies Review

, Volume 30, Issue 1, pp 65–85 | Cite as

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

  • Robert KollmannEmail author
Research Article
  • 43 Downloads

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.

Keywords

International business cycle synchronization Recursive preferences Terms of trade Real exchange rate Wealth effect on labor supply 

JEL Classification

F31 F32 F36 F41 F43 

Notes

Acknowledgements

I thank Giancarlo Corsetti, Nelson Mark, Kemal Özhan, Vincenzo Quadrini, Werner Roeger, Gauthier Vermandel, Roland Winkler and workshop participants at Fed Board of Governors, Dallas Fed, IMAC3, Korea University, MACFINROBODS, SED, Swiss National Bank and Bank or England for useful comments and discussions. The research leading to these results has received funding from the European Community’s Seventh Framework Programme (FP7) under grant agreement no. 612796, Project MACFINROBODS (‘Integrated Macro-Financial Modelling for Robust Policy Design’).

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.European Centre for Advanced Research in Economics and Statistics (ECARES)Université Libre de BruxellesBrusselsBelgium
  2. 2.Centre for Economic Policy Research (CEPR)LondonUK
  3. 3.Université-Paris Est CréteilCréteilFrance
  4. 4.Globalization and Monetary Policy Institute (Federal Reserve Bank of Dallas)DallasUSA
  5. 5.Centre for Applied Macroeconomic Analysis (CAMA)Australian National UniversityCanberraAustralia

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