Trade and fluctuations
A look at the data reveals that in OECD
            countries, economic fluctuations exhibit a high degree of
            synchronization. In 1965-90, cross-country contemporaneous
            GDP growth correlations averaged 45 percent. This suggests
            that a central element of any theory of economic
            fluctuations should be an explanation of how economic
            disturbances are transmitted across countries. But the large
            body of recent research that emphasizes productivity shocks
            as the source of fluctuations has been unsuccessful in this
            regard. The reason, the authors argue, is that these models
            have not properly addressed the role that commodity trade
            plays in economic fluctuations. The authors develop a
            stylized model of commodity trade and economic fluctuations
            that shows how economic disturbances are positively
            transmitted internationally, generating the high degree of
            synchronization in GDP growth rates of OECD countries from
            1965-90. The positive transmission mechanism is simple:
            international booms increase the prices of labor-intensive
            commodities, raising domestic wages and stimulating
            employment and output at home. This is the "wage
            effect." Empirically, this wage effect seems to be
            large enough to dominate the "interest rate
            effect" - that international booms also increase world
            interest rates, induce agents to invest abroad, reducing the
            domestic capital stock and output. While smaller than the
            wage effect, the negative transmission by way of the
            interest rate effect generates predictions that are
            consistent with existing evidence on current account
            fluctuations in the OECD. In particular, the model correctly
            predicts that capital should flow into those countries that
            experience a boom (relative to the rest of the world),
            producing current account deficits. The 1980s and early
            1990s have brough about rapid financial liberalization. To
            analyze the implications for the transmission mechanism, the
            authors also present a model of trade and fluctuations in
            which agents in some countries are allowed to trade
            financial assets across borders. This model yields the
            counterintuitive prediction that the current process of
            financial integration should lead to a lower degree of
            synchronization of economic fluctuations. While the wage and
            interest rate effects still operate in the second model,
            financial integration creates an additional transmission
            channel: the "risk-sharing effect." Since the
            domestic economy shares in the good times experienced in the
            rest of the world through financial risk-sharing agreements,
            international booms raise income at home and, provided
            leisure is a normal good, discourage employment and reduce
            output. This is a mechanism of negative transmission and
            reduces the predicted cross-country GDP growth correlations.
            Although theoretically interesting, evidence from the U.S.
            states suggests that this risk-sharing effect is small
            relative to the wage effect.