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Motivation

Global Business Cycles: Convergence or Decoupling? M. Ayhan Kose (IMF) Christopher Otrok (U of Virginia) Eswar Prasad (Cornell U) Disclaimer! The views presented here are those of the authors and do NOT necessarily reflect the views of the IMF or IMF policy. Motivation.

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Motivation

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  1. Global Business Cycles:Convergence or Decoupling?M. Ayhan Kose (IMF)Christopher Otrok (U of Virginia) Eswar Prasad (Cornell U)Disclaimer!The views presented here are those of the authors and do NOT necessarily reflect the views of the IMF or IMF policy.

  2. Motivation • Recent debates about convergence vs. decoupling in the context of a potential recession in the United States • What is decoupling? “Emerging economies will not follow the United States into recession…” • “Those arguing that Asia and other emerging markets can't decouple from the US are forgetting one very important fact — they already have.” (Robert Prior-Wandesforde, The Times, February 12) • “You either believe in decoupling or globalization- but not both”(Stephen Roach, Financial Times, Jan. 23)

  3. Motivation • And varieties of decoupling: an example from yesterday’s Financial Times • “The most likely outcome of any US recession is a “soft decoupling” in which the rest of the world slows a bit but avoids a recession, or a sharp decline in growth.” (Todd Rupert, Financial Times, June 25) • Why do we have the decoupling now?

  4. Growth Has Softened in the U.S.; But Remains Strong in Emerging Markets(Real GDP; percent change from four quarters earlier)

  5. What Explains World Growth?Developing Countries’ Share Increasing (based on PPP)

  6. Objective • To characterize the evolution of the degree of business cycle interdependence among industrial, emerging and other developing countries. Two questions: • What are the major factors (global vs. group-specific) driving business cycles in different groups of countries? • How have these factors evolved as the pace of globalization has accelerated over the past two decades? • How do we do it? Using a dynamic factor model with the data of 106 countries for the period 1960-2005.

  7. Results • Both the global and group-specific factors play important roles in explaining business cycles in 1960-2005. They are more significant in industrial countries. • The group-specific factors have become a major force in driving business cycles over time, but the importance of the global factor has decreased. • Convergence within groups; divergence (decoupling) across groups • Little change in the extent of cross-country business cycle synchronization over time.

  8. Outline of Presentation • Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  9. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  10. Globalization and Business Cycles in Theory Output Consumption Investment Comovement ?(-/+) (+) (-) Volatility ?(-/+) (-) (+) What do we learn from existing studies? • Theory: ambiguous about the impact of increased trade and financial linkages on the degree of business cycle comovement • Empirical studies: no concrete explanation about the evolution of business cycle comovement across industrial countries over time - Stock and Watson, 2005; Kose, Otrok and Whiteman, 2008

  11. What is our contribution? • Roles played by the global and group-specific cycles • A large (106 countries) and long (1960-2005) dataset • A tractable econometric model for a large dataset • Multiple variable approach; Exploiting cross-sectional dimension • Dynamic propagation of shocks

  12. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  13. Dataset • Annual data on Real Output, Consumption, and Investment growth, 1960-2005 • 106 Countries - Industrial (IND) Countries: 23 Core OECD Countries - Developing - Emerging Markets (EMEs): 24 Emerging Economies - Other Developing (ODCs): 59 Other Developing • Sources: World Bank WDI

  14. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  15. Dynamic Multi-factor Models • The multi-factor model we use decomposes macroeconomic fluctuations in the growth rates of output, consumption, and investment into the following factors: (i) A global factor: picks up fluctuations that are common across all variables and countries; (ii) Group-specific factors (Industrial, Emerging, and Other Developing Countries): capture fluctuations that are common to all variables and all countries in a given group; (iii) Country factors: common across all aggregates in a given country, and (iv) Idiosyncratic factors specific to each variable.

  16. The Model i,j,k(L) and m(L) : Lag polynomials ti,j,k ~ N(0,σ2i,j,k) ; tm ~ N(0, σ2m) tm and ti,j,k mutually orthogonal across all equations, variables Yti,j,k : growth rate of variable i in country j from group k Each factor, idiosyncratic component modeled as AR(3) process 3 variables per country (i), 106 countries (j), 3 groups of countries (k)

  17. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  18. What did we learn from factors? • The global factor is able to capture some of the major economic events of the past 45 years. • The group-specific factors are successful in reflecting some important business cycle turning points. • Global, group-specific, and country-specific factors play different roles at different points in time in different countries. • What is the quantitative importance of different factors in explaining the variations in output, consumption, and investment growth?

  19. Variance Decompositions • With orthogonal factors, the variance of the growth rate of output, • Then, the fraction of volatility due to the global factor • Cross-sectional means (within each group of countries) of the variance contributions of different factors to fluctuations in the three variables

  20. What did we learn (1960-2005)? • Both the global and group-specific factors play important roles in explaining business cycles • These factors appear to be more important in industrial countries than others • A larger fraction of output variation is captured by the global and group-specific factors than that of consumption variation • There are unexploited international consumption risk-sharing opportunities

  21. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  22. Evolution of Synchronization • Two periods: 1960-1984 and 1985-2005; Why 1984? • 1960-1984 (“Pre-globalization” period) - Weak global/group linkages and common shocks • 1985-2005 (“Globalization” Period) - Strong global/group linkages - Expansion of trade and financial flows - Increase in intra-industry/vertical trade flows - Rise in the number of regional trade agreements • Great Moderation: Structural decline in the volatility of business cycles in the mid-1980s (80 percent of the countries which have a break in the unconditional variance experience that break in or before 1984)

  23. Evolution of Financial and Trade Liberalization(Fraction of Liberalized Countries, percentage)

  24. Evolution of Trade Openness( (Exports+Imports)/GDP, percentage)

  25. Evolution of Synchronization • Global factor has become less important. Global factor has become less important for fluctuations in INCs and EMEs -- true for Y, C, I • Group-specific factors have become more important. Relative variance contribution of group-specific factors has gone up for INCs and EMEs • Total variance contribution of the two common factors has not changed much

  26. What Did We Learn? • Global factor has become less important. Why? - Large common disturbances during the pre-globalization period—the two oil prices shocks—and some correlated shocks in the major industrial countries. - Disappearance of these during the globalization period • Group-specific factors have become more important. Why? - Increase in intra-group trade and financial linkages among industrial countries and EMEs after the mid-1980s - Intra-group trade linkages have become stronger among EMEs during this period. - EMEs’ trade with the group of industrial countries as a share of the EMEs’ total trade has declined from 70 percent to 50 percent. - Increase in the pace of diversification of their industrial (and trade) bases; accompanied with a greater degree of sectoral similarity across countries within each group.

  27. Emerging Markets’ Trade with Other Groups(Fraction of the Total Trade from Emerging Markets to Others, percent)

  28. Sensitivity Analysis • Are key results driven by specific groups of countries? No! • Do crises matter? No! • Does the choice of breakpoints drive the results? No! • Re-estimated model for break dates from 1983 to 1987 • Are results driven by certain individual countries? No!

  29. Review of theory and empirical studies; Contribution • Dataset • Econometric Model • Results for 1960-2005 • Results for 1960-1984 and 1985-2005 • Conclusions

  30. Results • QUESTION 1: What are the major factors (global vs. group-specific) driving business cycles in different groups of countries? • Both the global and group-specific factors play important roles in explaining business cycles in 1960-2005. They are more significant in industrial countries. • QUESTION 2: How have these factors evolved as the pace of globalization has accelerated over the past two decades? • The group-specific factors have become a major force in driving business cycles, but the importance of the global factor has decreased. • Little change in the extent of cross-country business cycle synchronization over time.

  31. Implications for the Decoupling Debate • More nuanced picture of convergence / decoupling debate emerges from data; convergence within groups; divergence (decoupling) across groups • Our large cross-section and demarcation of time period essential to uncover key results • Factors such as relative level of development and levels of trade and financial integration appear to matter for determining business cycle spillovers • Data continue to exhibit puzzles relative to the predictions of conventional theoretical models

  32. Work in Progress/Future Research • Financial convergence + real decoupling ? - Financial shocks get transmitted quickly - How do real and financial variables comove? • Nonlinearities - Large shocks in U.S. may have spillover effects; smaller shocks may not (recessions vs. slowdowns) • Sectoral linkages - Spillovers through different sectors: industry, service and agriculture

  33. Questions & Comments M. Ayhan Kose akose@imf.org

  34. A new question for the new century?Probably Not! "For the past hundred years, the rate of growth of output in the developing world has depended on the rate of growth of output in the developed world. When the developed grow fast, the developing grow fast, and when the developed slow down, the developing slow down. Is this linkage inevitable?" Sir Arthur Lewis, 1979 Nobel Prize lecture

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