The Transmission Mechanisms of International Business Cycles: Output Spillovers through Trade and Financial Linkages
International trade and financial linkages may be an important channel through which economic shocks propagate across countries. For example, a contractionary U.S. monetary policy shock may reduce U.S. demand for foreign goods through the income effect, with a negative impact on foreign economies. Moreover, U.S. banks may reduce the supply of credit to foreign borrowers. The strength of these effects likely depends on the size and the patterns of international trade and financial linkages. In addition, a chain of indirect effects could further amplify these direct spillovers. Despite the salience of such spillovers and the greatly increased economic effects of globalization in the last few decades, the literature provides only fragmented answers to many important questions: How large are international spillovers relative to domestic effects? Through which international linkages do shocks propagate across countries? Are the indirect effects of output spillovers quantitatively important?
This paper sheds new light on these questions by studying how domestic aggregate shocks transmit across borders through the networks formed by bilateral trade and financial linkages, thereby engendering cross-country comovement in real economic activity. The authors focus on U.S. monetary shocks, since they are often perceived as an important driver of international business cycles due to the size of the U.S. economy and the dollar’s role as a dominant currency.