Many authors have investigated domestic business cycles within the framework of dynamic neoclassical general equilibrium models. These real business cycle models assert that a single aggregate technological shock can account for a significant portion of the fluctuations of actual economies. In Discussion Paper No. 1113, Research Fellow Fabio Canova and Angel Ubide contribute to this literature by examining the properties of an international business cycle model with household production. The model is rich enough to allow for several types of mechanisms transmitting cycles across countries. First, international cycles will emerge because shocks are correlated across countries. Second, shocks to the market technology will produce international repercussions because of imports and exports of capital. Lastly, shocks to the household technology create international cycles because of consumption interdependencies across countries.

There are three symmetric versions of the model: a benchmark model where only disturbances to the market technology are present; a second where only disturbances to the household technology exist; and a third with both types of shocks. When only household production disturbances are present, the model is able to reproduce the main regularities of international business cycles. When both types of disturbances are present, the model is able to account for several previously unexplained features of the data, including the low cross-country correlation of consumption and the positive cross-country correlation of output and investment. Overall, the addition of household production significantly improves the fit of the standard model. Introducing cross-country asymmetries to the process for the disturbances, the authors find that the basic features of the simulations do not change, and that the results are largely insensitive to the choice of parameters within a reasonable range. The only parameters which are important in determining the qualitative features of the simulations are those describing the elasticity of substitution between imports and exports and the share of imports.

Household Production and International Business Cycles
Fabio Canova and Angel J Ubide

Discussion Paper No. 1113, February 1995 (IM)