DP3268 Financial Globalization and Real Regionalization

Author(s): Jonathan Heathcote, Fabrizio Perri
Publication Date: March 2002
Keyword(s): international business cycles, international diversification
JEL(s): F36, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3268

Over the period 1972-86, the correlations of GDP, employment and investment between the United States and an aggregate of Europe, Canada and Japan were respectively 0.76, 0.66 and 0.63. For the period 1986 to 2000 the same correlations were much lower: 0.26, 0.03, and -0.07 (real regionalization). At the same time, US international asset trade has significantly increased. For example, between 1972-99, United States gross FDI and equity assets in the same group of countries rose from 4 to 23% of the US capital stock (financial globalization). We document that the correlation of real shocks between the US and the rest of the world has declined. We then present a model in which international financial market integration occurs endogenously in response to less correlated shocks. Financial integration further reduces international correlations in GDP and factor supplies. We find that both less correlated shocks and endogenous financial market development are needed to account for all the changes in the international business cycle.