Thesis advisor: Susanto Basu / Thesis advisor: Fabio Ghironi / Empirical studies highlight that countries that trade intermediate goods exhibit more synchronized business cycles. This positive correlation raises the question of causality. Traditional theoretical mechanisms propose the direction where higher bilateral trade in intermediate goods causes increased business cycle correlations. However, the data shows that trade is positively correlated with comovements in GDP as well as total factor productivity (TFP) and the current work in the literature explains only the first relation. I build a small open economy model that makes two contributions -- first, it predicts both positive correlations as seen in the data. Second, it explains potential causality in the reverse direction, i.e. countries might choose trade partners based on the properties of their business cycles. Specifically, the model predicts that when the elasticity of substitution between domestic capital and intermediate imports is low, i.e. the country is constrained by domestic technology, there is greater benefit from trading with a positively correlated source and self-insuring through capital accumulation. I provide empirical evidence of this condition in the data by estimating the elasticity of substitution between capital and intermediates by industry using a panel of countries. We use annual time series data and filtering methods to document the key statistics of the India business cycle. Output, consumption and investment are more volatile than in developed economies. Like in developed countries, consumption is less volatile and investment is more volatile than output in the Indian data. Unlike in the former, investment is not highly correlated with output. We test whether a standard real business cycle model with technology and fiscal shocks, with parameters calibrated for the Indian economy can replicate the features of the business cycle. / Thesis (PhD) — Boston College, 2011. / Submitted to: Boston College. Graduate School of Arts and Sciences. / Discipline: Economics.

This dissertation is a collection of essays on challenges in international trade and international finance, which apply econometric methods to diverse data sets and relate them to economic policy questions. In times of crises, the question, whether individual countries have the ability to pursue idiosyncratic monetary policy, is important. The degree of integration and comovement between financial markets, for instance, is critical to better assess the real threat facing a country in a crisis. Also, from a macroeconomic modeling perspective, there has recently been a renewed interest in the cyclical and long-run comovement of interest rates. Hence, in a first essay, we reinvestigate the long- and short-run comovements in the G7-countries by conducting tests for cointegration, common serial correlation and codependence with nominal and real interest rates. Overall, we only find little evidence of comovements: common trends are occasionally observed, but the majority of interest rates are not cointegrated. Although some evidence for codependence of higher order can be found in the pre-Euro area sample, common cycles appear to exist only in rare cases. We argue that some earlier, more positive findings in the literature are difficult to reconcile due to differing assumptions about the underlying stochastic properties of interest rates. Hence, we conclude that they cannot be generalized for all interest rates, time periods, and reasonable alternative estimation procedures. This finding indicates that scope for individual countries to pursue stabilization policy does still exist in a globalized world. Emerging economies, in general, are much more exposed and vulnerable to crises than industrialized countries. Accordingly, stabilization policy is especially important in these countries and the selection of the best monetary regime is essential. This is why, in a second essay, we contrast two different views in the debate on official dollarization: the Mundell (1961) framework of optimum currency areas and a model on boom-bust cycles by Schneider and Tornell (2004), who take account of credit market imperfections prevalent in middle income countries. We highlight the strikingly different role of the exchange rate in the two models. While in the Mundell framework the exchange rate is expected to smooth the business cycle, the second model predicts the exchange rate to play an amplifying role. We empirically evaluate both models for eight highly dollarized Central American economies. We document the existence of credit market imperfections and find that shocks from the exchange rate indeed amplify business cycles in these countries. Using a new method proposed by Cubadda (1999 and 2007), we furthermore test for cyclical comovement and reject the hypothesis that the selected countries form an optimum currency area with the United States according to the Mundell definition. In the context of the recent global crisis, globalization and vertical integration in particular were often blamed for being the cause for the severe trade crisis. For that reason, in the essay that contributes to the trade literature, we analyze the role of international supply chains in explaining the long-run trade elasticity and its short-term volatility in the context of the recent trade collapse. We adopt an empirical strategy based on two steps: first, stylized facts on long- and short-term trade elasticity are derived from exploratory analysis and formal modeling on a large and diversified sample of countries. Then, we derive observations of interrelated input-output matrices for a demonstrative sub-set of countries. We find evidence for two supply chain related factors to explain the overshooting of trade elasticity during the 2008-2009 trade collapse: the composition and the bullwhip effect. However, evidence for a magnification effect could not be found. Overall, we do not accept the hypothesis that international supply chains explain all by themselves the changes in trade-income elasticity.