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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 320:
Financial Autarky and International Business Cycles

Jonathan Heathcote and Fabrizio Perri

Abstract: We present a two-country, two-good model in which there do not exist any markets for international trade in financial assets. We compare the predictions of this model to those of two other models, one in which markets are complete and a second in which a single non-contingent bond is traded. We find that only the financial autarky model can generate volatility in the terms of trade similar to that in data for floating rate period and, at the same time, account for observed cross-country output, consumption, investment and employment correlations. We interpret our findings as evidence that the extent of international borrowing and lending opportunities is important for the international business cycle.

Keywords: International business cycles; incomplete markets.; (follow links to similar papers)

JEL-Codes: E32; F32; F33; F41; (follow links to similar papers)

29 pages, May 19, 1999, Revised April 30, 2000

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