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

28 Pages Posted: 22 Mar 2017

See all articles by Robert Kollmann

Robert Kollmann

ECARES, Université Libre de Bruxelles; University of Paris XII - Department of Economics; Centre for Economic Policy Research (CEPR)

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Date Written: March 20, 2017

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 commove 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

Suggested Citation

Kollmann, Robert, Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel (March 20, 2017). CAMA Working Paper No. 21/2017 , Available at SSRN: https://ssrn.com/abstract=2938208 or http://dx.doi.org/10.2139/ssrn.2938208

Robert Kollmann (Contact Author)

ECARES, Université Libre de Bruxelles ( email )

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Brussels, B-1050
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University of Paris XII - Department of Economics ( email )

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Creteil cedex, 94010
France

HOME PAGE: http://www.robertkollmann.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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