# **6.2** **_Business cycle statistics: some key stylized facts_**

Hereafter, we discuss how the standard deviation of consumption, of output and their ratio change when we move from financial autarky ( _m_ = 0) to a high degree of financial integration ( _m_ = 0 _._ 8) keeping the degree of trade integration constant equal to its baseline value ( _τ_ = 0 _._ 2).

Financial liberalization works through 2 main channels. For an impatient borrower, a relaxed borrowing constraint works as positive income shock. Given the same amount of collateral, he borrows more because he can accede to more resources and he consumes more because he prefers current to future consumption. Moreover, the larger availability of foreign borrowing allows both a higher consumption and a higher demand for real estate. This implies a raise in the real estate prices and therefore in the value of the collateral. Overall, a higher capital account openness increases consumption volatility and the volatility of consumption relative to that of output. The standard deviation of consumption goes from 0 _._ 92 in financial autarky to 1 _._ 04 in a financially integrated market. The relative volatility of consumption to output goes from 0 _._ 4181 in financial autarky to 0 _._ 4601 in a financially integrated market<sup>7</sup> . Figure 3 shows the sensitivity of the consumption volatility over that of output to a variation of the degree of financial integration. Deeper international financial integration worsens consumption smoothing.

Then, we keep the level of financial integration constant equal to its baseline value ( _m_ = 0 _._ 4) and we change the extent of trade integration passing from low integration ( _τ_ = 0 _._ 50) to free trade ( _τ_ = 0). As we mentioned above, a positive productivity shock in the Home country leads to an increase in the domestic output and to a decline in its price. The terms of trade of the other country improves, raising employment, investment, output and consumption in the Foreign country. The improvement in the terms of trade of the Foreign country is larger under free trade than under low trade integration. The different behavior of the Foreign terms of trade depends on the different dynamics of the intermediate goods prices at different degree of trade openness. Trade costs introduce a wedge between the Home and the Foreign price of the same intermediate good traded across countries. Only under free trade the two prices are equated. Thus, only under free trade the decline in the domestic price of the intermediate good traded to the other country is fully transmitted into its foreign price. Therefore, free trade strengthens the response of the Foreign variables to a domestic productivity shock and through them produces an amplification mechanism which reinforces the reaction of all the domestic variables but consumption. Under free trade, the response of domestic consumption to the productivity shock is weaker because of the

> moments are obtained shocking productivity in both countries. All series have been logged (except net exports) and Hodrick-Prescott filtered with a smoothing parameter of 1600.

> 7The statistics for capital liberalization are reported in Table 5. The statistics for trade liberalization are reported in Table 6. Volatility is measured by the theoretical standard deviation. Contemporaneous comovement is measured by the theoretical correlation. The simulated moments are obtained shocking productivity in both countries. All series have been logged (except net exports) and Hodrick-Prescott filtered with a smoothing parameter of 1600.

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