Financial Integration and Business Cycle Synchronization
44 Pages Posted: 21 Mar 2009
Date Written: February 2009
Abstract
Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a novel dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous work, we find that a higher degree of financial integration is associated with less synchronized cycles. The instrumental variable specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the bilateral exchange rate regime has a negative effect on output synchronization.
Keywords: Financial Integration, Banking, Co-movement, Regulation
JEL Classification: G21, E32, F15, F36, O16
Suggested Citation: Suggested Citation