Integration, decoupling and the global financial crisis: A global perspective

Abstract

The recent global recession requires policy makers to identify the relative importance of shock transmission mechanisms in each region and devise counter policy measures against future idiosyncratic shocks. In the last decade, world dynamics have changed considerably due to increased openness and integration requiring considering business cycles at regional levels. This paper analyzes the business cycle movements of the EU, ASEAN+3, NAFTA, MERCOSUR and SAARC regions to investigate why the subprime mortgage crisis of 2007 did not spread globally compared to the crisis that began with the fall of Lehman Brothers in September 2008. Employing a Panel Vector Autoregressive framework (PVEC), this study finds that the subprime mortgage crisis shock originated in the real sector (falling US housing prices) and was transmitted through trade variables. Due to absence of short term trade variables transmission mechanism in all regions except the MERCOSUR and SAARC, the shock did not spread widely to other regions. Even in the MERCOSUR and SAARC, due to limited goods exports exposure to the US, the shock was not significant. Resultantly, these regions exhibited a decoupling phenomenon during the subprime mortgage crisis. In contrast, the second shock originated with the fall of Lehman Brothers in 2008 and was transmitted through financial variables. Due to the presence of the short term causal relationship of the financial variable with GDP in all regions except SAARC, the slowdown contagion spread to most regions. As a result, the slowdown triggered the trade variables shock transmission mechanism and the SAARC region was also affected. Consequently, a business cycle convergence phenomenon was observed in the regions. Therefore, business cycles decoupling and convergence phenomena in the regions depend not only on the origin of the shock but also on the relative importance of the transmission mechanisms in each region.Integration, Decoupling, Financial crisis, EU, NAFTA, ASEAN, MERCOSUR, SAARC, Business cycle, FDI, Exports, Intra industry Trade, Sub prime mortgage crisis, Lehman Brothers, Short term capital flows, Panel Cointegration, Panel stationarity, Panel Vector Error Correction (PVEC)