International information flows, sentiments and cross-country business cycle fluctuations

Abstract

Business cycles are strongly correlated between countries. One possible explanation (beyond traditional economic linkages like trade or finance) is that consumer or business sentiments spread over boarders and a ect cyclical uctuations in various countries. We first lend empirical support to this concept by showing that sentiments travel between countries at a speed much higher than can be explained by traditional linkages. Then we construct a two-economy new Keynesian model where noisy international information can generate cyclical fluctuations (comovement of GDP, consumption, investment and in ation) in both countries. Estimation with US and Canadian data reveals a significant role of international noise shocks in generating common fluctuations - they explain between 15-30% of consumption variance in the US and Canada and raise the correlation between these variables by up to unity in periods of sentiment breakdowns. We also show that our estimated noise shock has a clear interpretation as a sentiment shock.