Business Cycles No Longer Linked

"Despite efforts to coordinate economic policy, business cycles are more likely to follow one pattern in the G-7's 'Euro-zone countries' and another in the G-7's 'English-speaking countries.'"

In Understanding Changes in International Business Cycle Dynamics (NBER Working Paper No. 9859), NBER Research Associates James Stock and Mark Watson observe that, despite efforts to coordinate economic policy, business cycles are more likely to follow one pattern in the G-7's "Euro-zone countries" and another in the G-7's "English-speaking countries." That latter group includes the United Kingdom, a member of the European Union but a country whose business cycles recently have mirrored North American economies. Meanwhile, the authors find that "during the 1980s and 1990s, cyclical fluctuations" in Japan's gross domestic product or GDP have become "almost detached from other G-7 economies."

But these various differences, while intriguing, may not necessarily be a bad thing. Stock and Watson find that the growing lack of "synchronization among G-7 business cycles" is linked to some decidedly good news. They assert that the one reason these various economies appear to be marching to their own drummers is that international economic shocks have been "smaller in the 1980s and 1990s than they were in the 1960s and 1970s." This change has had a positive effect on individual economies, making them less volatile than they were 40 years ago. It also, in a sense, has freed them to be different.

In addition, the fact that business cycles in the G-7 are "less synchronous" than they used to be should not be read as a sign that G-7 countries are drifting apart, at least in the economic sense. Stock and Watson note that G-7 countries are more tightly integrated today than they were 40 years ago. And, if they were again subjected to the kinds of economic shocks they experienced in the 1960s and 1970s, the economic conditions throughout the G-7 would become more volatile. Essentially, those now diverging business cycles would be shocked into a level of conformity exceeding that of the 1960s and 1970s.

The main outlier in this analysis, Stock and Watson observe, is Japan. While in other G-7 countries economic volatility either decreased or, at worst, stayed the same in the 1990s, in Japan volatility increased. Furthermore, as was noted previously, the contrast between Japan's business cycles and those of other G-7 members has become particularly pronounced.

Stock and Watson believe that Japan's issues speak more to its internal economic problems and growing economic ties to Asia than to a degradation of its relationship with G-7 countries. They point to internal "domestic shocks" as being responsible for "almost all of the cyclical movements in Japanese GDP," while its contrasting economic conditions also are "consistent with Asian trade being increasingly important for the Japanese economy."

Finally, Stock and Watson find that three countries -- Canada, France, and the United Kingdom -- appear to be particularly sensitive to potentially destabilizing economic events. They note that, "in those countries, a shock of a given magnitude would result in more cyclical volatility today than 30 years ago."

-- Matthew Davis

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