Finance and International Business Cycles

Business cycles are more correlated among countries that have similar financial structures. We

first document this empirical regularity using OECD data, and then build a two-country DSGE

model with financial frictions that replicates it. Alternative monetary policy regimes and parameter values are explored. Output co-movements increase when the countries involved are linked by a credible exchange rate peg and when they open up to trade; they decrease when their financial openness increases. The model also accounts for a number of stylized facts of international business cycles, such as the positive international correlation of output, investment and employment.