Working Paper

International Credit Markets and Global Business Cycles


Abstract: This paper stresses a new channel through which global financial linkages contribute to the co-movement in economic activity across countries. We show in a two-country setting with borrowing constraints that international credit markets are subject to self-fulfilling variations in the world real interest rate. Those expectation-driven changes in the borrowing cost in turn act as global shocks that induce strong cross-country co-movements in both financial and real variables (such as asset prices, GDP, consumption, investment and employment). When firms around the world benefit from unexpectedly low debt repayments today, they borrow and invest more, which leads to excessive supply of collateral and of loanable funds at a low interest rate, thus fueling a boom in both home and foreign economies. As a consequence, business cycles are synchronized internationally. Such a stylized model thus offers one way to rationalize both the existence of world business-cycle factor documented by recent empirical studies through dynamic factor analysis and such a factor?s intimate link to global financial markets.

Keywords: World Interest Rate; International Co-Movement; Self-Fulfilling Equilibria;

JEL Classification: E21; E22; E32; E44; E63;

https://doi.org/10.20955/wp.2018.009

Access Documents

File(s): File format is application/pdf https://s3.amazonaws.com/real.stlouisfed.org/wp/2018/2018-009.pdf
Description: Full text

File(s): File format is text/html https://doi.org/10.20955/wp.2018.009
Description: https://doi.org/10.20955/wp.2018.009

Authors

Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2018-05-14

Number: 2018-9