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Federal Reserve Bank of St. Louis
Working Papers
Contagious Switching
Michael T. Owyang
Jeremy M. Piger
Daniel Soques

In this paper, we analyze the propagation of recessions across countries. We construct a model with multiple qualitative state variables that evolve in a VAR setting. The VAR structure allows us to include country-level variables to determine whether policy also propagates across countries. We consider two different versions of the model. One version assumes the discrete state of the economy (expansion or recession) is observed. The other assumes that the state of the economy is unobserved and must be inferred from movements in economic growth. We apply the model to Canada, Mexico, and the U.S. to test if spillover effects were similar before and after NAFTA. We find that trade liberalization has increased the degree of business cycle propagation across the three countries.

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Michael T. Owyang & Jeremy M. Piger & Daniel Soques, Contagious Switching, Federal Reserve Bank of St. Louis, Working Papers 2019-14, 13 May 2019.
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Keywords: time varying transition probabilities; NAFTA; business cycle synchronization
DOI: 10.20955/wp.2019.014
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