Multiple Determinants of Business Cycle Synchronization

This study looks at the major economic linkages explaining real GDP correlations for 51 countries including 27 emerging markets for the 1970-2008 period. The GMM-IV and 3SLS simultaneous equation models show that trade integration, especially in the form of intra-industry trade, and similarity in economic structures are the most important determinants of output correlations. On average, global financial integration has no significant effect on output synchronization. However, for developed country pairs and developed and emerging market pairs, financial integration lowers business cycle synchronization, whereas for emerging markets, financial integration increases synchronization. There are strong indirect effects from financial openness to trade integration and structural convergence. In addition, FTA membership, trade partner diversification, differences in fiscal spending, and stability of bilateral exchange rates increase output correlations. Similar oil import dependencies increase synchronization primarily among developed country pairs.