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International Business Cycles and Financial Frictions

Author

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  • Wen Yao
Abstract
This paper builds a two-country DSGE model to study the quantitative impact of financial frictions on business cycle co-movements when investors have foreign asset exposure. The investor in each country holds capital in both countries and faces a leverage constraint on her debt. I show quantitatively that financial frictions along with foreign asset exposure give rise to a multiplier effect that amplifies the transmission of shocks between countries. The key mechanism is that a negative shock in the home country reduces the wealth of investors in both countries, which tightens their leverage constraints, leading to a fall in investment, consumption, and hours worked in the foreign country. Compared to the existing literature, which tends to produce either negative or positive but small cross-country correlations, this model produces positive and sizable correlations that are consistent with the data. The model can account for most of the investment, employment and consumption correlations and predicts more than half of the output correlation. In addition, the model shows that, consistent with empirical findings, when investors have more foreign asset exposure to the other country, the output correlation between the two countries increases.

Suggested Citation

  • Wen Yao, 2012. "International Business Cycles and Financial Frictions," Staff Working Papers 12-19, Bank of Canada.
    • Handle: RePEc:bca:bocawp:12-19
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    3. Maksim Evseevich Krivelevich, 2019. "Export-Oriented Financial Center in the Russian Far East: Abstraction or Reality?," Spatial Economics=Prostranstvennaya Ekonomika, Economic Research Institute, Far Eastern Branch, Russian Academy of Sciences (Khabarovsk, Russia), issue 2, pages 75-91.
    4. Georgiadis, Georgios & Jančoková, Martina, 2020. "Financial globalisation, monetary policy spillovers and macro-modelling: Tales from 1001 shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    5. Debarsy, Nicolas & Dossougoin, Cyrille & Ertur, Cem & Gnabo, Jean-Yves, 2018. "Measuring sovereign risk spillovers and assessing the role of transmission channels: A spatial econometrics approach," Journal of Economic Dynamics and Control, Elsevier, vol. 87(C), pages 21-45.
    6. Letendre, Marc-André & Wagner, Joel, 2018. "Agency Costs, Risk Shocks, And International Cycles," Macroeconomic Dynamics, Cambridge University Press, vol. 22(5), pages 1134-1172, July.
    7. PIROVANO, Mara, 2013. "International financial integration, credit frictions and exchange rate regimes," Working Papers 2013015, University of Antwerp, Faculty of Business and Economics.
    8. Paul De Grauwe & Yuemei Ji, 2016. "Animal Spirits and the International Transmission of Business Cycles," CESifo Working Paper Series 5810, CESifo.
    9. Campo Elias Lopez-Rodriguez & Gerson Jaquin Cristancho-Triana & Jenny Liliana Amaya-Tellez, 2020. "Perception and Desired Brand Personality in Organizations that Internationalize Services: The Case of the Colombian Business Environment," European Research Studies Journal, European Research Studies Journal, vol. 0(3), pages 581-597.
    10. De Grauwe, Paul & Ji, Yuemei, 2017. "Endogenous Asymmetric Shocks in the Eurozone. The Role of Animal Spirits," CEPR Discussion Papers 11887, C.E.P.R. Discussion Papers.
    11. Anna Watson, 2021. "Trade credit, trade income elasticity and the international transmission of shocks," Eurasian Economic Review, Springer;Eurasia Business and Economics Society, vol. 11(4), pages 687-733, December.
    12. Agénor, Pierre-Richard & Jackson, Timothy P. & Pereira da Silva, Luiz A., 2024. "Cross-border regulatory spillovers and macroprudential policy coordination," Journal of Monetary Economics, Elsevier, vol. 146(C).
    13. Tang, Aidi & Yao, Wen, 2022. "The effects of financial integration during crises," Journal of International Money and Finance, Elsevier, vol. 124(C).
    14. Ohdoi, Ryoji, 2020. "Trade, Growth, and the International Transmission of Financial Shocks," MPRA Paper 100756, University Library of Munich, Germany.
    15. Been-Lon Chen & Yunfang Hu & Kazuo Mino, 2020. "Capital Allocation and Wealth Distribution in a Global Economy with Financial Frictions," KIER Working Papers 1045, Kyoto University, Institute of Economic Research.
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    More about this item

    Keywords

    Business fluctuations and cycles; International financial markets; International topics;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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