Discussion Paper Series 2010-E-16

Banking Globalization and International Business Cycles

Kozo Ueda

This paper constructs a two-country DSGE model to study the nature of the recent financial crisis and its effects that spread immediately throughout the world owing to the globalization of banking. In the model, financial intermediaries (FIs) enter into chained credit contracts at home and abroad, engaging in cross-border lending to entrepreneurs by undertaking cross-border borrowing from investors. The FIs as well as the entrepreneurs in two countries are credit constrained, so all of their net worths matter. Our model reveals that under FIs' globalization, adverse shocks that hit one country affect the other, yielding business cycle synchronization on both the real and financial sides. It also suggests that the FIs' globalization, net worth shock, and credit constraints are key to understanding the recent financial crisis.

Keywords: Financial accelerator; financial intermediaries; correlation (quantity) puzzle; business cycle synchronization; contagion; monetary policy

Views expressed in the paper are those of the authors and do not necessarily reflect those of the Bank of Japan or Institute for Monetary and Economic Studies.

Copyright © 2010 Bank of Japan All Rights Reserved.

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