Time-Separability, Wealth Effects and International Business Cycles

This paper addresses the international comovement puzzle. International real business cycle models tend to predict negative cross-country correlations of investment and employment. In the data these correlations are positive. To reconcile the theory with the data the literature has resorted to financial frictions and new sources of disturbances. We show that a model driven by productivity shocks alone can account for the comovement puzzle in a complete markets environment. Our two-country model with imperfectly substitutable traded intermediate goods features time nonseparable preferences that allow arbitrarily small wealth effects on labor supply. It reconciles with the data by predicting (i) positive cross-country correlations of investment and hours worked; (ii) a plausible cross-country correlation of output; and (iii) countercyclical net exports. Although our model cannot reproduce the observed volatility of relative prices, it improves slightly on standard approaches. Unlike models with incomplete markets, ours show little sensitivity to the degree of persistence or international spillovers of the shocks.