This research will study how different types of macroeconomic and financial disturbances, or ?shocks?, are propagated across countries in a highly integrated world economy. These shocks could have their origins either in policy actions of national governments or as outcomes of market forces. The implications of these shocks for business cycle comovement across countries are of considerable interest from both analytical and policy perspectives.
The research is motivated by a few empirical observations. First, there have been enormous changes in the global economic landscape since the mid-1980s. These changes include the sharp increases in cross-border trade and financial flows, and the rising prominence of emerging market economies. Second, spillovers of shocks across financial markets and real economic activity have intensified, both within and across economies. Third, the recent global financial crisis has dramatically highlighted the linkages across economies that acted as channels for spillovers of shocks.
The project will address two key questions concerning macro-financial linkages, which refers to the increasingly close ties between macroeconomic variables, such as GDP and employment, and financial market variables, such as stock market indexes and interest rates. First, what are the implications of rising macro-financial linkages for the synchronization of business and financial cycles? Second, are common shocks or the propagation of country-specific shocks the key to synchronicity of business and financial cycles across countries? If it is the latter, what are the main channels for the propagation of shocks across different groups of countries?
To address these issues, the project will involve the development of a new econometric model that captures different aspects of international business cycle comovement and permits differentiation between true ?shocks? and their propagation effects. Another innovation is that the model will be used to study the roles of financial shocks and their spillovers in driving business cycle comovement of real macroeconomic aggregates.
The project will transform the growing debate on the implications of globalization with new evidence on how this phenomenon has affected the nature of cross-country economic and financial relationships. The results generated by the study will provide guidance for policy makers in evaluating the propagation channels for major shocks/crises that originate in one country but affect others. This is essential for designing effective stabilization policies at the national level and for coordination of policies at the international level.
