Closer to Home

• Author: Hideaki Hirata, M. Ayhan Kose, and Christopher Otrok
• Position: a Professor of Business Administration at Hosei University and a Visiting Scholar at Harvard University. is Assistant to the Director in the IMF's Research Department. is the Sam B. Cook Professor of Economics at the University of Missouri and a Research Fellow at the Federal Reserve Bank of St. Louis.

The inexorable forces of globalization and regionalization have reshaped the world economic landscape over the past quarter century. While international trade flows have been growing at a much faster rate than global output, trade flows within regions of countries have been playing an even more prominent role in world trade. Economic linkages within regions have also become much stronger with the proliferation of regional trade agreements. Moreover, while the volume of global financial flows has reached unprecedented levels since the mid-1980s, overshadowing the increase in global trade over the same period, financial flows within regions have also been on the rise for the past 15 years, especially in Europe and Asia.Â

These developments appear to have affected the evolution of global and regional business cycles in unexpected ways. For example, despite the presence of strong global trade and financial linkages, there has been significant variation in growth performance across different regions since the 2008–09 financial crisis (Kose and Prasad, 2010). Some regions—such as Asia, Latin America, the Middle East and North Africa, and sub-Saharan Africa—exhibited surprising resilience during the worst of the financial crisis and rapidly returned to growth, whereas others—mainly North America and Europe—experienced deep and prolonged contractions that were followed by sluggish recoveries or double-dip recessions.

This behavior has raised the question of whether regional factors have become more important in driving business cycles in an era of globalization. On the one hand, globalization of trade and finance is expected to translate into stronger linkages across national business cycles and eventually lead to a situation in which business cycles move together simultaneously across the world. On the other hand, if the effects of regional linkages are stronger than those of global linkages and regionwide shocks—that is, unexpected events affecting an entire region—influence activity more than global ones, then one would expect business cycles to be increasingly regional.Â

Economic theory is unable to provide definitive guidance concerning the impact of increased international trade and financial linkages on the degree of synchronization of global and regional cycles. As a result, we turn to a novel empirical approach that has the potential to provide a comprehensive perspective on the importance of global and regional business cycles (Hirata, Kose, and Otrok, forthcoming).Â

Specifically, we employed a newly developed methodology to study the roles played by global and regional factors in driving national business cycles. We end up with the surprising conclusion that regional, rather than global, factors play an increasingly prominent role in explaining national business cycles.Â

Studying regional cycles

The methodology allowed us to consider fluctuations in three major macroeconomic variables for each country: output, consumption, and investment. It is critical to isolate business cycle fluctuations that are accounted for by regional factors (for example, common regional cyclical movements due to regional trade...