Dancing in Unison?

• Author: Robin Brooks/Kristin Forbes/Jean Imbs/Ashoka Mody
• Position: Economist in the IMF's Research Department/Associate Professor of International Management at MIT-Sloan School of Management/Assistant Professor of Economics at the London Business School/Division Chief in the IMF's Research Department
• Pages: 46-49

Economists lack evidence of increasing synchronization of the world's economies

Page 46

Globalization is increasing the links between the world's economies, particularly through capital markets and trade flows. Does the growing importance of these links mean that international policy coordination is now a necessity for effective policy-making? How sensible is it, in an increasingly global economy, to make policy decisions largely at the national level? These questions came to the fore when, after a decade of economic expansion, growth slowed simultaneously in early 2000 in the advanced economies known as the Group of Seven (G-7)-Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States.

Researchers were interested in two key issues. To what extent did the slowdown in growth result from an adverse global shock that affected these economies simultaneously? And to what extent did it result from faster transmission of shocks across borders? Because global shocks are rare and their effects temporary, they are of less concern. In contrast, national economies are constantly buffeted by economic shocks. Faster cross-border transmission of these shocks can cause national economies to move in step, or comove, on a permanent basis. This increased comovement could reduce their ability to steer their own economy out of trouble. What, then, are the sources of comovement? Are they transitory, the result of a global shock, or permanent-a sign that the rise in global linkages is bringing economies, and thus national policies, closer together?

Researchers looking into this complex issue make a distinction between financial market synchronization and synchronization of what they term the "real" economy, such as the output of goods and services as measured by GDP. What they have found is that, although the increase in financial market comovement is relatively clear and consistent, evidence of increased comovement of the real economy is blurred and controversial. While stock prices in the advanced economies may move in parallel much of the time, the degree of synchronization of the real economy is substantially lower.

Differing views

Measuring comovement is not simple, and there are various ways to look at the numbers. Charts 1 and 2 show that stock market correlations between the United States and other advanced and emerging markets, respectively, are generally higher than GDP correlations for the same markets. While financial comovement increased in the 1990s, especially for stock markets in the G-7, correlations between real variables (such as GDP growth) have not clearly increased over time. For the G-7 economies, real correlations may have increased in the late 1990s along with financial correlations, but they were still lower than in the early 1990s. In emerging markets, although financial market correlations are lower than for the G-7, they have also increased steadily.

Page 47

Chart 1

In step . . .

The degree of comovement across national stock markets in the G-7 rose dramatically in the late 1990s, while the extent to which business cycles are synchronized across these countries has been broadly stable.

[ SEE THE GRAPHIC AT THE ATTACHED PDF ]

The rise in financial market correlations in the 1990s is associated with greater financial openness. Chart 3 shows a small increase in trade openness in the 1990s, but a much larger increase in financial openness (measured as the amount of international assets and liabilities a country holds relative to its GDP). Chart 4 shows that cross-border holdings of equities also increased over the 1990s, implying a reduction in the so-called home bias in equity portfolios. This was driven largely by a steady opening of countries' international capital accounts.

Greater policy openness fostered a strong increase in capital...