# **3.5 Financial interconnection**

As shown in Kalemli-Ozcan et al. (2013), financial interconnection is significantly (and _negatively_ ) associated with GDP comovements. They show that, in periods without financial crises, an increase in bilateral banking linkages is associated with _more divergent_ output cycles. Such a result is consistent with a _resource shifting hypothesis_ where an integration of capital market between two countries means that global savings are invested in the countries with the highest marginal productivity of capital – at the expense of investment in the rest of the world. in other words, if savings can be allocated across borders, then a positive technological shock in one country relative to its partners creates an inflow of capital into this country at the expense of other economies.

In this section, we test the empirical trade co-movement relationship while controlling for financial interconnection. Table 7 presents the results with country pairs where information on bilateral financial linkages are available using cross country claims from the Bank of International Settlements (see section 2). Results show that once we control for such financial interconnections, trade and GDP comovement remain significant and positive correlated.<sup>21</sup>

**Table. 7.** The impact of financial integration: Bank for International Settlements

|||corr G|DP<sup>_HP_</sup>|||corr G|DP<sup>_BK_</sup>|||corr|∆GDP||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
||(1)|(2)|(3)|(4)|(5)|(6)|(7)|(8)|(9)|(10)|(11)|(12)|
|ln(_TP_)|**0.056**<sup>_∗∗∗_</sup><br>(0.017)|**0.059**<sup>_∗∗∗_</sup><br>(0.017)|||**0.046**<sup>_∗∗∗_</sup><br>(0.017)|**0.051**<sup>_∗∗∗_</sup><br>(0.018)|||0.013<br>(0.017)|0.018<br>(0.018)|||
|ln(_TPI_+_K_)|||**0.032**<sup>_∗∗_</sup>|**0.035**<sup>_∗∗_</sup>|||**0.032**<sup>_∗_</sup>|**0.035**<sup>_∗∗_</sup>|||0.010|0.013|
||||(0.016)|(0.016)|||(0.017)|(0.017)|||(0.017)|(0.017)|
|ln(_TPf inal_)|||0.023<sup>_∗_</sup>|0.024<sup>_∗_</sup>|||0.011|0.013|||_−_0.006|_−_0.004|
||||(0.014)|(0.014)|||(0.014)|(0.014)|||(0.014)|(0.014)|
|ln(_FP_)||_−_0.007||_−_0.007||_−_0.010||_−_0.010||_−_0.011||_−_0.010|
|||(0.008)||(0.008)||(0.008)||(0.008)||(0.008)||(0.008)|
|_thirdEX_|**0.376**<sup>_∗∗∗_</sup><br>(0.131)|**0.382**<sup>_∗∗∗_</sup><br>(0.131)|**0.381**<sup>_∗∗∗_</sup><br>(0.131)|**0.387**<sup>_∗∗∗_</sup><br>(0.131)|0.187<br>(0.135)|0.196<br>(0.135)|0.197<br>(0.135)|0.205<br>(0.135)|**0.417**<sup>_∗∗∗_</sup><br>(0.137)|**0.426**<sup>_∗∗∗_</sup><br>(0.137)|**0.435**<sup>_∗∗∗_</sup><br>(0.137)|**0.443**<sup>_∗∗∗_</sup><br>(0.138)|
|_thirdIM_|**0.521**<sup>_∗∗∗_</sup><br>(0.156)|**0.528**<sup>_∗∗∗_</sup><br>(0.156)|**0.535**<sup>_∗∗∗_</sup><br>(0.156)|**0.543**<sup>_∗∗∗_</sup><br>(0.156)|**0.549**<sup>_∗∗∗_</sup><br>(0.160)|**0.560**<sup>_∗∗∗_</sup><br>(0.160)|**0.559**<sup>_∗∗∗_</sup><br>(0.160)|**0.570**<sup>_∗∗∗_</sup><br>(0.161)|**0.417**<sup>_∗∗_</sup><br>(0.164)|**0.429**<sup>_∗∗∗_</sup><br>(0.164)|**0.426**<sup>_∗∗∗_</sup><br>(0.164)|**0.437**<sup>_∗∗∗_</sup><br>(0.164)|
|CP FE|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|
|TW FE|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|
|Controls|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|Yes|
|_N_<br>|3,723|3,723|3,723|3,723|3,723|3,723|3,723|3,723|3,723|3,723|3,723|3,723|
|R<sup>2</sup>|0.346|0.346|0.346|0.346|0.344|0.345|0.344|0.345|0.289|0.289|0.289|0.289|
|_Notes:_|_∗_p_<_0.1;|_∗∗_p_<_0.05;|_∗∗∗_p_<_0.01|. In pare|nthesis: st|d. deviatio|n.||||||

21Notice however that we do not find that more bilateral financial linkage is correlated with GDP comovement. However, as compared to Kalemli-Ozcan et al. (2013), we rely solely on gross bilateral claims for all sectors and instruments while they focus on the banking sector and net bilateral claims, which is possible to construct only for a small sample of countries. Still, consistent with their findings, the point estimate is negative.

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