Bilateral Linkages and the International Transmission of Business Cycles

Comovement is more than correlation. This paper estimates the contributions of intermediate production linkages, trade patterns, and financial holdings on the directed graph of linkages that describe the international propagation of macroeconomic shocks at the business cycle frequency. The empirical methodology is a novel generalization of the panel vector autoregression (VAR) which nests both the Global VAR and a VAR with linearly time-varying coefficients. The key novel stylized facts are: 1) trade and financial linkages are associated with transmission of shocks at a lag of one quarter, 2) import and export intensity are asymmetrically associated with shock transmission, and 3) the import of goods used for capital formation has the largest and most significant association with transmission of shocks. In effect, the novel stylized facts in this paper refine the “trade-comovement” puzzle into the “trade-correlation” puzzle and the “tradetransmission” puzzle. I show that both puzzles are challenges for standard international business cycle models, and that an application of sticky information to importing firms can help resolve part of the “trade-transmission” puzzle, especially in combination with other mechanisms that help resolve the “trade-correlation” puzzle.