Financial autarky and international business cycles

We present a two-country, two-good model in which there do not exist any markets for international trade in financial assets. We compare the predictions of this model to those of two other models, one in which markets are complete and a second in which a single non-contingent bond is traded. We find that only the financial autarky model can generate volatility in the terms of trade similar to that in data for the floating rate period and, at the same time, account for observed cross-country output, consumption, investment and employment correlations. We interpret our findings as evidence that the extent of international borrowing and lending opportunities is important for the international business cycle. (C) 2002 Elsevier Science B.V. All rights reserved.