Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 320: Financial Autarky and International Business Cycles

Jonathan Heathcote and Fabrizio Perri
Additional contact information
Jonathan Heathcote: Dept. of Economics, Stockholm School of Economics, Postal: P.O. Box 6501, S-113 83 Stockholm, Sweden
Fabrizio Perri: Stern School of Business, Postal: New York University, 70 Washington Square South, New York, NY 10012, USA

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.

JEL-codes: E32; F32; F33; F41

29 pages, First version: May 19, 1999. Revised: April 30, 2000.

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