On the international transmission of productivity shocks

This paper represents a contribution to the study of the international transmission of business cycle shocks. A domestic positive productivity shock hitting countries vis-à-vis the rest of the world is identified in a VAR model following the methodology of sign restriction pioneered by Canova and De Nicolò in 2002. By this identification strategy, restrictions are imposed on impulse response functions of selected variables and based on robust predictions arising from standard theory, namely the least controversial implications of the shock and the characteristics that seem to be the distinguishing features of that particular disturbance compared to other shocks prominently proposed in the literature. Crucially, the sign of the impulse response functions of variables of interest is left agnostically open. The results show that positive productivity shocks do not necessary have depreciating effects on relative prices: they generate an appreciation of both the real exchange rate and the terms of trade in a big and close economy (US) and a depreciation of the two relative prices in a small and open economy (UK). These findings are in line with a growing new literature on international business cycle transmission stressing strong wealth and demand effects in a framework of incomplete markets. Overall, these results suggest that international risk sharing finds no empirical support.