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On the Transmission Mechanism of International Business Cycles


Models that feature endogenously determined trade patterns are able to capture many features of international business cycle transmission. Although these models are "Ricardian" in the sense that countries trade labor services, changes in employment are often omitted (labor is supplied inelastically). The effect of foreign booms and recessions on domestic labor markets can therefore not be analyzed, and hence these models overlook an important mechanism of business cycle transmission across countries. Further, these models often omit capital in the production of goods. "Investment" in the model is defined as new firm construction, which does not compare well to the empirical measure of investment. This dissertation develops a two-country dynamic stochastic general equilibrium model featuring an endogenously determined trade pattern. Employment dynamics are added to the model by allowing households to choose how much labor to supply every period. The model generates high output volatility, procyclical employment and positive correlation of employment across countries. Capital is then added to the production of non-traded final goods. The model produces high international correlations of output, consumption and investment when shocks to the production of final non-traded goods are considered. Further, the model is able to reproduce high volatility of imports, exports and the exchange rate, features that past literature had difficulty capturing.

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