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Title: Financial Integration and Business Cycle Synchronization

Author(s): Sebnem Kalemli-Ozcan, Elias Papaioannou and Jos� Luis Peydr�

Publication Date: May 2009

Keyword(s): Banks, Business Cycles, Co-movement, Financial Integration and Financial Regulation

Programme Area(s): International Macroeconomics

Abstract: Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.

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Bibliographic Reference

Kalemli-Ozcan, S, Papaioannou, E and Peydr�, J. 2009. 'Financial Integration and Business Cycle Synchronization'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=7292