M. Ayhan Kose
The process of globalization, which refers to the rising trade and financial integration of the world economy, has recently attracted much interest. A growing research program has sought to examine how globalization has affected the synchronization of business cycles across different countries. Changes in synchronization have important implications for the conduct of macroeconomic policy at the domestic and international levels. This article briefly surveys recent research on the effects of increasing integration on the synchronization of business cycle fluctuations in main macroeconomic aggregates.
Understanding changes in the degree of synchronization of business cycles is of considerable interest from a policy perspective in a number of respects. With stronger business cycle transmission, policy measures taken by one country could have a larger impact on economic activity in other countries, implying that the degree of synchronization of business cycle fluctuations has important implications for international policy coordination (Obstfeld and Rogoff, 2002).
If global factors play a dominant role in explaining business cycles, domestic policies targeting external balances to stabilize macroeconomic fluctuations might have a limited impact. The extent of business cycle synchronization among a group of countries is also an important criterion in determining whether a currency union among those countries is desirable and feasible.
Economic theory does not provide a definitive conclusion regarding the impact of globalization on the synchronization of business cycles (Brooks and others, 2003). Increased trade in goods would normally be expected to heighten both demand- and supply-side spillovers across countries. However, Kose and Yi (2001) show that higher trade intensity leads to lower business cycle correlations in standard international business cycle models because favorable shocks to a country’s productivity lead capital and other resources to move to that country. If industry-specific shocks are important in driving business cycles, increased intra-industry specialization across countries can increase cyclical comovement, but the degree of comovement might fall if inter-industry trade linkages are spurred.
Recent empirical research finds that stronger trade linkages have a positive impact on cross-country output correlations. For example, based on cross-country or cross-region panel regressions, Frankel and Rose (1998), Clark and van Wincoop (2001), Kose and Yi (2002), and Imbs (2004a, 2004b) show that, among advanced countries, pairs of countries that trade more with each other exhibit a higher degree of business cycle comovement.
The theoretical effect of increased financial flows on cross-country output correlations depends on the nature of shocks and specialization patterns. For instance, stronger financial linkages could generate higher cross-country synchronization of output by allowing easier spillovers of demand-side shocks. However, financial linkages could stimulate specialization of production through the reallocation of capital in a manner consistent with countries’ comparative advantage. This type of specialization, which could result in more vulnerability to industry- or country-specific shocks, could lead to a decrease in the degree of output correlations while inducing stronger comovement of consumption across countries (Kalemli-Ozcan, Sorensen, and Yosha, 2003).
Recent empirical studies conclude that increased financial integration leads to higher business cycle comovement. Imbs (2004a, 2004b) shows that financial linkages are important in accounting for the synchronization of output fluctuations. Financial integration, by helping countries to diversify away country-specific risks associated with output fluctuations, should result in stronger comovement of consumption across countries. Imbs (2004a) documents that financial integration leads to higher cross-country consumption correlations among advanced economies. Kose, Prasad, and Terrones (2004) find that, for advanced countries, cross-country investment correlations have increased over time.
Other studies analyze the impact of globalization on the synchronization and volatility of business cycle fluctuations among developing countries. Kose, Prasad, and Terrones (2003b) document that, on average, cross-country consumption correlations did not increase in the 1990s, precisely when financial integration would have been expected to result in better risk-sharing opportunities, especially for emerging market countries. Kose, Prasad, and Terrones (2003a) find that emerging market economies did not enjoy any sizable decrease in the volatility of consumption during the 1990s and lack of international risk sharing remains an important problem for these countries.
Several recent empirical studies examine how the dynamics of comovement of business cycles across advanced countries have evolved over time. The results of these studies indicate that differences in country coverage, sample periods, aggregation methods used to create country groups, and econometric methods employed could lead to diverse conclusions about the temporal evolution of business cycle synchronization. For example, some of these studies find evidence of declining output correlations among advanced economies over the last three decades. Helbling and Bayoumi (2003) find that correlation coefficients between the United States and other G-7 countries for the period 1973–2001 are substantially lower than those for 1973–89. In a related paper, Heathcote and Perri (2003) examine the correlations of output, consumption, and investment between the United States and the rest of the world, which is defined as an aggregate of Europe, Canada, and Japan. They find that the cross-country correlations are lower in 1981–2002 than those in 1960–81.
However, other studies document that business cycle linkages have become stronger over time. Kose, Prasad, and Terrones (2003b, 2004) study the correlations between the fluctuations in individual country aggregates (output, consumption, and investment) and those in corresponding world (G-7) aggregates using annual data over the period 1960–99. They find that, for advanced countries, the correlations on average increase sharply in the 1970s (the oil shock period) and rise further in the 1990s. Using a much longer sample of annual data (1880–2001), Bordo and Helbling (2003) document that the degree of synchronization across advanced countries has increased over time.
Studies employing recently developed econometric methods, such as dynamic factor models, seem to provide a more consistent description of the evolution of business cycle comovement. These methods allow estimation of the extent to which common or country-specific factors explain the changes in the comovement, and also help take into account potentially important “leads” and “lags” in the cross-correlation of different macroeconomic variables. Using these methods, recent studies find strong evidence of a common (world) factor that plays an important role in driving business cycles in advanced countries (Stock and Watson, 2003; Helbling and Bayoumi, 2003; Nadal-De Simone, 2002; and Lumsdaine and Prasad, 2003). This implies that there exists a world business cycle that describes fluctuations common across all advanced countries. Kose, Otrok, and Whiteman (2003) extend this research by analyzing how the world factor affects business cycles in developing countries. They find that the world factor plays a much smaller role in explaining business cycles in developing countries than it does in advanced economies.
Is the world factor becoming more important in explaining business cycles over time, suggesting a higher degree of business cycle synchronization? Stock and Watson (2003) find that, in some of the G-7 countries (Canada, Italy, and the United States), the importance of international factors in explaining business cycles is higher during 1984–2002 than that in 1960–83. Kose, Otrok, and Whiteman (2004) document that the world factor, on average, explains a larger share of business cycle variation in the G-7 countries during the globalization period (1986–2002) than it does during the Bretton Woods period (1960–72). Indeed, this is the case in all countries except Germany and Japan, where the relative importance of domestic developments (unification in Germany and prolonged slowdown in Japan) has likely swamped the effect of increasing globalization.
Finally, recent research examines how the emergence of regional trading blocks affects the synchronization of business cycles in different parts of the world. Caldéron (2003) shows that free trade agreements have a positive impact on the degree of business cycle synchronization across the member countries. Kose (2004) and Kose, Meredith, and Towe (2004) find that the North American Free Trade Agreement has led to a substantial increase in the degree of business cycle synchronization across Canada, Mexico, and the United States. Employing a time-varying weighting procedure for constructing common components, Lumsdaine and Prasad (2003) show that business cycle fluctuations are closely finked across European countries, implying that there is a European business cycle. Using dynamic factor models, Canova, Ciccarelli, and Ortega (2003) and Kose, Otrok, and Whiteman (2003) find that, while business cycles in European countries display comovement, the source is not distinctly European, but rather worldwide.
IMF Study on Hong Kong SAR Hong Kong SAR: Meeting the Challenges off Integration with the Mainland
Edited by Eswar Prasad, with contributions from Jorge Chan-Lau, Dora lakova, William Lee, Hong Liang, Ida Liu, Papa N’Diaye, and Tao Wang
This Occasional Paper provides an overview of the main challenges facing Hong Kong SAR as it continues to become more closely integrated with the Mainland of China. Section I summarizes the recent macroeconomic developments and the main policy issues in Hong Kong SAR. Section II presents the various dimensions of the ongoing economic and financial integration with the mainland, the outlook for further integration of these economies, and the associated implications for the structure of the economy and for macroeconomic and structural policies. Section III examines the medium-term fiscal outlook under different policy scenarios and discusses alternative policy options to restore fiscal balance. Section IV discusses recent developments in the real estate sector and their macroeconomic impact. Section V presents a comprehensive econometric analysis of deflation in Hong Kong SAR. Section VI analyzes the factors behind and the implications of rising wage inequality in Hong Kong SAR. Section VII analyzes recent developments in the financial sector and assesses Hong Kong SAR’s future prospects as an international financial center.
This study was issued as IMF Occasional Paper No. 226.
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Kose, M. Ayhan, ChristopherOtrok, and CharlesH. Whiteman,2004, “Understanding the Evolution of World Business Cycles,”IMF Working Paper, forthcoming.
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Rawi Abdeial; Harvard Business School
Reena Aggarwal; Georgetown University
Alarudeen Aminu; University of Ibadan and University of Lagos, Nigeria
Alessio Anzuini; Bank of Italy, Italy
Omoregba Aregbeyen; Ahmadu Bello University, Zaria, Nigeria
Jushan Bai; New York University
Roel Beetsma; University of Amsterdam, The Netherlands
Michael Bordo; Rutgers University
Fabio Canova; Universitat Pompeu Fabra, Spain
Allan Drazen; University of Maryland
Abiodun Folawewo; University of Ibadan, Nigeria
Simon Johnson; Massachusetts Institute of Technology
Rafael La Porta; Tuck School of Business
Olayinka Lawanson; University of Ibadan, Nigeria
David Leblang; University of Colorado
Shawn Leu; University of Sydney, Australia
Enrique Mendoza; University of Maryland
Marcelo Muinhos; Banco Central do Brasil, Brazil
Ousmanou Njikam; University of Yaoundé II, Cameroon
Tatsuyoshi Okimoto; University of California at San Diego
Sawa Omori; University of Pittsburgh
David Parsley; Owen Graduate School, Vanderbilt University
Sergio Rebelo; Northwestern University
Carmen Reinhart; University of Maryland
Andrey Romanov; University of Wisconsin
Christopher Sims; Princeton University
Federico Sturzenegger; Universidad Torcuato Di Telia, Argentina
Lars Svensson; Princeton University
Mark Taylor; Warwick University, United Kingdom
Helmut Wagner; University of Hagen, Germany
Beatrice Weder; University of Mainz, Germany