Abstract:

This paper proposes a factorial multivariate approach to measure the impact of financial integration on international business cycles induced by business cycle synchronization (BCS). By allowing bilateral financial integration to load both on quantity and price measures, we document a negative and significant direct effect on BCS, in line with what would be expected by standard theories. However, we also find positive and strong indirect effects of financial integration on BCS running through trade integration and structural similarity. Although such positive indirect effects have also been found elsewhere in literature, we by contrast find their magnitude to override the negative direct effect. This finding reveals the complex nature of the economic networks and is relevant for policy makers considering joining or leaving currency areas.