Modeling time-variation over the business cycle (1960–2017): an international perspective

In this paper, I explore the changes in international business cycles with quarterly data for the eight largest advanced economies (US, UK, Germany, France, Italy, Spain, Japan, and Canada) since the 1960s. Using a time-varying parameter model with stochastic volatility for real GDP growth and inflation allows their dynamics to change over time, approximating nonlinearities in the data that otherwise would not be adequately accounted for with linear models [Granger, Clive W.J., Timo Terasvirta, and Heather M. Anderson. 1991. “Modeling Nonlinearity over the Business Cycle.” In NBER book Business Cycles, Indicators and Forecasting (1993), edited by James H. Stock and Mark W. Watson, University of Chicago Press.; Granger, Clive W.J. 2008. “Non-Linear Models: Where Do We Go Next – Time Varying Parameter Models?” Studies in Nonlinear Dynamics and Econometrics 12 (3): 1–11.]. With that empirical model, I document a period of declining macro volatility since the 1980s, followed by increasing (and diverging) inflation volatility since the mid-1990s. I also find significant shifts in inflation persistence and cyclicality, as well as in macro synchronization and even forecastability. The 2008 global recession appears to have had an impact on some of this. I ground my empirical strategy on the reduced-form solution of the workhorse New Keynesian model and, motivated by theory, explore the relationship between greater trade openness (globalization) and the reported shifts in international business cycle. I show that globalization has sizeable (yet nonlinear) effects in the data consistent with the implications of the model – yet globalization’s contribution is not a foregone conclusion, depending crucially on more than the degree of openness of the international economy.