What Matters More for Business Cycles: Global or Regional Factors?

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This is the first of a three-part series examining the comovement of business cycles among countries. Today’s post will look at whether global factors or regional factors play larger roles in business cycles.

Business cycles, or the movement of economies between expansions and recessions, can be correlated across countries. A recent article in The Regional Economist examined what causes these cycles to move together.¹

The authors broke down business cycles into three components:

• A global component, which captures the common movements in all countries’ business cycles
• A regional component, which captures the common movements with a country’s neighbors
• A country component, which captures the movements in the business cycle that are unique to that country

The authors noted that the strength of the correlation of countries’ business cycles depends on the relative importance of these components. They wrote, “For example, if the regional component of a country’s cycle is larger than the global and country components, the country may appear more synchronized with its neighbors than with the world as a whole.”

The authors cited a 2003 paper by economists Ayhan Kose, Christopher Otrok and Charles Whiteman, which found that the global and country components explained a substantial portion of the cyclical movements for most of the 60 countries studied, while regional components explained far less.²

In that paper, the comovement of all 60 countries is significant: Fifteen percent of the deviation in world output growth away from the norm was experienced by all 60 countries, as was 9 percent of the deviation in world consumption and 7 percent of the deviation in investment growth. In their Regional Economist article, the authors wrote, “The importance of the global component suggests some interconnectedness across all of the countries during world economic downturns.”

They also noted that some countries were more interconnected than others. Regarding the Group of 7,³ for example, the fluctuations in output growth explained by the global component more than doubled, and the share of fluctuations in consumption growth explained by the global component more than quadrupled.

The regional components, however, explained only a small percentage of business cycle fluctuations, with the regions in the paper being defined based on geography. The regional component for (pre-European Union) Europe, for example, explained only 2 percent of the variation in the three economic variables.

However, the regional component has become more important in recent years, according to more recent research.⁴ Also, defining “region” differently than via simple geography impacts the regional component. Our next blog post will explore the regional component more deeply.

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 Kose, M.A.; Otrok, Christopher; and Whiteman, Charles H. “International Business Cycles: World, Region and Country-Specific Factors,” The American Economic Review, September 2003, Vol. 93, No. 4, pp. 1,216-39.

³ The Group of 7 countries are Canada, France, Germany, Italy, Japan, the United Kingdom and the United States.

⁴ 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.

Follow the Series:

• What Matters More for Business Cycles: Global or Regional Factors?
• The Effect of Regional Factors on National Business Cycles
• Are Links between Countries’ Business Cycles Increasingly Global or Regional?

Additional Resources

• Regional Economist: Regional vs. Global: How Are Countries’ Business Cycles Moving Together These Days?
• On the Economy: What Determines How Much Countries Trade?
• On the Economy: What Drives Long-Run Economic Growth?