Papers highlighted this week:

Democracies are less likely to go to war but both sides must want peace

DP3947 It Takes Two: An Explanation of the Democratic Peace

Authors: Gilat Levy (London School of Economics and CEPR) and Ronny Razin (New York University)

June 2003

A well-established empirical observation in the international relations literature is that democratic regimes rarely wage war against each other. Conflicts that involve non-democratic regimes, on the other hand, whether faced with democratic or autocratic rivals are found to have a higher chance of leading to war. This phenomenon is known as the 'Democratic Peace Hypothesis', and has been described as ' as close as anything we have to an empirical law in international relations'. In this Paper, Levy and Razin provide an explanation of the democratic peace hypothesis, i.e., the observation that democracies rarely fight one another. The crux of the matter lies in explaining why democracies would behave in dramatically different ways than non-democratic rivals.

The explanation they suggest relies on asymmetric information, which is widely recognized as an important obstacle for peaceful resolution of conflicts. Countries are often uncertain about the ' true' preferences of rival countries. This information is important when calculating the future benefits of making costly concessions. Moreover, even within a country, information is unevenly distributed. Some citizens, such as political leaders, may know more than the general public about the desirability of a peaceful versus a military resolution of a dispute. In their model, two democracies induce the highest probability of peaceful resolution of conflicts. But it takes two for peace; one democracy involved in a conflict does not necessarily increase the probability of a peaceful resolution compared to a conflict between two non-democratic regimes.

The US Fed should learn to think global

DP3963 The Transmission of US Shocks to Latin America

Author: Fabio Canova (University of Pompeu, Barcelona and CEPR)

July 2003

In the last 20 years researchers have examined sources of cyclical movements in US economic activity using a variety of techniques. The findings, however, have often been contradictory. In CEPR Discussion Paper no.3963, Canova studies whether and how US shocks are transmitted to eight Latin American countries. Canova finds that US Monetary shocks produce significant fluctuations in Latin America, but real demand and supply shocks do not.

Countries that use floating exchange rates or currency boards display similar output responses but different inflation and interest rate responses. The financial channel plays a crucial role in the transmission. US disturbances do matter for Latin American countries and explain important portions of the variability. The results of the investigation have important policy implications: putting the house in order is far from being sufficient to avoid undesired fluctuations in Latin American economies. Given that the majority of domestic fluctuations in the continent is of foreign origin, Latin America policy-makers are required to carefully monitor international conditions and to disentangle the content of US disturbances in order to react fully to external imbalances. The US Fed should also take these external effects into account. The lack of a global perspective may in fact produce destabilizing consequences in Latin America that may feed back into the US economy.

10 Discussion Papers by CEPR this week: