Financial Crises Yield More Synchronized Economic Output

Regional and global output see increased correlations during financial crises

Size of output spillovers depends on type of shock and strength of linkages with originating economy

Financial globalization doesn’t necessarily induce greater output synchronization across countries—till crisis hits

The output performance of the world’s economies moved together during the peak of the global financial crisis as never before in the recent history, according to a study published in the IMF’s October 2013 World Economic Outlook report. Correlations of various countries’ GDP growth rates had been modest before the crisis but rose dramatically during 2007–09 (see Chart 1).

The increased correlation or “comovement” was not confined to the advanced economies—which suffered most from the crisis—but was observed across all geographic regions. As in past episodes when output correlations spiked, the increase was temporary. In fact since 2010 output comovements have returned close to precrisis levels despite continued economic turmoil in Europe.

Lively debate persists on what caused the globally synchronized collapse and recovery and more generally what makes countries’ economies move together.

Trade and financial linkages are the most likely explanation because they can transmit country-specific shocks to other countries.

A second possibility is that greater comovements in output were induced by large, common shocks simultaneously affecting many countries at approximately the same time—such as a sudden increase in financial uncertainty or a “wake-up call” that triggered a change in investors’ perceptions of the world.

Finally, it could be that the nature of shocks changed. Shocks to countries’ financial sectors, such as banking crises and liquidity freezes, were more prevalent during the global financial crisis. These financial shocks might be transmitted to other countries in a more virulent manner during crises than are the supply and demand shocks—that are more prevalent during normal times.

Global spikes

Even though financial linkages may have played some role in pushing up comovements, the study finds that big spikes in regional and global output correlations tend to occur during financial crises, such as those in Latin America in the 1980s and in Asia in the 1990s. Moreover, when the crisis occurs in an economy like the United States—which is both large and a global financial hub—the effects on global output synchronization are disproportionately...