Product Prices Link Business Cycles among Major Industrialized Countries

"Manufacturing employment, hours worked, and real wages are all highly correlated among OECD countries."

One of the characteristics of the modern era has been a discernible pattern of synchronized business cycles among the major developed economies. New research by Aart Kraay and Jaume Ventura sheds light on the reasons behind this trend; their findings may not only improve our understanding of the channels through which our economies are linked but also could have important implications for economic policy.

In Product Prices and the OECD Cycle (NBER Working Paper No. 7788), the authors build a case for the possibility that the cyclical nature of product prices might help to explain why business cycles are synchronized in the OECD. As a first step, they present evidence supporting the notion that the peak of the OECD business cycle is associated with high prices of labor-intensive products and low prices of capital-intensive products. Interestingly, the authors show that these cyclical movements in relative prices are driven by OECD-wide shocks, and not by country-specific ones. Kraay and Ventura then argue that this evidence is consistent with the view that shifts in the demand for labor tend to occur at the same time in all OECD countries. In particular, they observe that manufacturing employment, hours worked, and real wages are all highly correlated among OECD countries.

Armed with this evidence, the authors build a model of how an economic expansion in one country would increase the demand for labor not only in that country but in the rest of the OECD as well. Higher demand for labor would lead to higher employment growth and wages, creating an economic expansion in other countries as well. The authors then use the model to make some quantitative sense of how much of the synchronization of business cycles can be explained through this mechanism. Their main conclusion is that this mechanism might be important, but it cannot alone totally explain the extent to which business cycles are synchronized among OECD countries. In short, movements in the relative price of labor- and capital-intensive products do play a part in the process by which economic expansions are transmitted across countries, but it is only a part and not the whole story.

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