Trade and Synchronization in a Multi-Country Economy

Abstract

Substantial evidence suggests that countries or regions with stronger trade linkages tend to have business cycles that are more synchronized. The standard international business cycle framework cannot replicate this nding. In this paper, we study a multi-country model of international trade with vertical trade linkages, imperfect competition, and variable markups. We embed it in a real business cycle framework by including aggregate technology shocks and allowing for a variable labor supply. A carefully calibrated version of the theoretical economy that ts the model to data on the bilateral trade volume between 210 distinct country-pairs explains between 20 and 41 percent of the relation between trade intensity and business cycle synchronization. We provide empirical evidence supporting the model's predictions for the association between trade costs and business cycle synchronization, and exchange rate volatility and business cycle synchronization.Trade Integration, Business Cycle Synchronization