Banking globalization and international business cycles

By Kozo Ueda

http://d.repec.org/n?u=RePEc:fip:feddgw:58&r=dge

This paper constructs a two-country DSGE model to study the nature of the recent financial crisis and its effects that spread immediately throughout the world owing to the globalization of banking. In the model, financial intermediaries (FIs) enter into chained credit contracts at home and abroad, engaging in cross-border lending to entrepreneurs by undertaking crossborder borrowing from investors. The FIs as well as the entrepreneurs in two countries are credit constrained, so all of their net worths matter. Our model reveals that under FIs’ globalization, adverse shocks that hit one country affect the other, yielding business-cycle synchronization on both the real and financial sides. It also suggests that the FIs’ globalization, net worth shock, and credit constraints are key to understanding the recent financial crisis.

The rapid contagion of the recent crisis has been surprising. In fact, the high synchronization of business cycles across industrialized economies has been puzzling. For example, Jonathan Heathcote and Fabrizio Perri documented in 2004 that synchronization was disappearing and built an international business cycle model to explain it. The current decade may not only be the continuation of financial globalization that Heathcote and Perri talk about, but also that banks are more global, with different consequences, as Uedo tries to document. If data keeps changing, we will keep digging for better or new theories…