International Transmission and Real Business Cycle Models

Recent progress on closed-economy models of real business cycles has prompted similar attempts at quantitative studies of business cycles in open economies. An attempt is made to derive new implications of real business cycle models for variables that do not appear in closed-economy models, such as the balance of trade and terms of trade. This will help in discriminating among alternative specifications of models and sources of shocks. Reasonable specifications can be made qualitatively consistent with a set of observations about international comovements of output, consumption, Solow residuals, the trade balance, and relative prices. In addition, the channels and dynamics of international transmission are studied, and a more complete dynamic model of international trade is developed. Two distinct but connected areas of research are integrated - business cycle models and models of exchange rates, both of which are based on real disturbances.