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Are Links between Countries’ Business Cycles Increasingly Global or Regional?

Friday, June 19, 2015
world business cycles
Thinkstock/Hermann Liesenfeld

This is the third of a three-part series examining the comovement of business cycles among countries. Today’s post will look at whether economic linkages are becoming increasingly global or increasingly regional.

In previous blog posts, based on a recent article in The Regional Economist,1 we’ve seen that global and country components play a bigger role in countries' business cycles than regional components and that the importance of the regional component increases when considering countries that have similar attributes, rather than ones that are simply near each other.

Today’s post will focus on how economic linkages have changed in recent decades: Have they become increasingly global or increasingly regional? The authors of The Regional Economist article discussed a 2013 paper that examined two periods—1960-1984 and 1985-2010—during which the number of regional trade agreements jumped from five to 200 and during which global and financial flows increased substantially.2

According to the paper’s findings, the average contribution of global factors to fluctuations in the output growth rate fell from 13 percent in the first period to 9 percent in the second. In contrast, the average contribution of regional factors to fluctuations in the output growth rate rose from 11 percent in the first period to 19 percent in the second.

The Regional Economist article authors noted that the increase in regional trade agreements over the past 30 years might help explain the increasing significance of economic linkages. For example, the establishment of the European Union and the eurozone increased intraregional trade flows in Europe to roughly 75 percent of total trade during the past decade.

The authors concluded by noting that understanding the nature of comovement of business cycles is important for the formulation of domestic policies to stabilize business cycles. They explained, “If business cycles are largely global in nature, then domestic policy within one country will have little impact on the nation’s economy, unless accompanied by global economic reform. If business cycles are largely regional in response to trade agreements, one should consider coordinating macroeconomic stabilization policies as part of the formulation of a free-trade zone. Lastly, domestic policy should focus on smoothing business cycle fluctuations that are primarily determined by the country-specific cycle rather than those determined by the global and regional components.”

Notes and References

1 The article was written by Assistant Vice President and Economist Michael Owyang, Senior Research Associate Diana Cooke, Research Fellow Christopher Otrok—all with the St. Louis Fed—and M. Ayhan Kose, director of the Development Prospects Group at the World Bank. (Otrok is also the Sam B. Cook Professor of Economics at the University of Missouri.)

2 Hirata, Hideaki; Kose, M.A.; and Otrok, Christopher. “Closer to Home,” Finance and Development, International Monetary Fund, September 2013, Vol. 50, No. 3, pp. 40-43.

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