The International Business Cycle as Intertemporal Coordination Failure
62 Pages Posted: 1 Nov 2015
Date Written: November 1, 2015
Abstract
Where investments are irreversible and future uncertain, people in two countries can make investment decisions that turn out to be mutually inconsistent. I argue that this intertemporal coordination failure explains international business cycles in a two-currency-area setting. The sequence of events starts with a domestic expansionary monetary shock, which decreases the domestic real interest rate. Facing low transactions costs, people spend the new money relatively early in the foreign exchange market and in the foreign market for loanable funds. Domestic monetary expansion thereby changes the relative prices of domestic and foreign goods and also of goods of earlier and later stages of production. The relative price changes lead to intertemporal and international coordination failures once the monetary expansion ends and relative prices change. Domestic monetary policy thereby causes the comovement we observe of business cycles across different currency areas.
Keywords: Hayek, nonneutrality of money, intertemporal coordination failure, international business cycle, structure of production
JEL Classification: F21, F31, F44
Suggested Citation: Suggested Citation