Financial and trade integrations on international business cycle under market imperfection and heterogeneous agents

Abstract

This thesis studies the effect of financial integration (FI) together with trade integration (TI) on international business cycles and different types of market participants in emerging markets under the presence of financial frictions and imperfect access to finance. The study adopted dynamic stochastic general equilibrium (DSGE) framework and developed three international real business cycle (RBC) models to examine FI from various aspects.

The simulation results show that the effect of FI on macroeconomic volatility and business cycle synchronization is mixed likely depending on TI, types of financial flow, severity of market frictions, and financial accessibility. Consumption smoothing benefit and welfare gain from higher FI are small or absent when market imperfection exists. People with more financial restrictions and no unconstrained domestic markets to rely on tend to be more negatively affected by increasing FI. TI generally lowers output and consumption fluctuation, increases business cycle synchronization, and slightly enhances welfare. Some evidences suggest that the impact of FI is weakened under higher trade possibly because FI and TI affect business cycles in opposite directions and their impacts might offset each other. Overall, there is a trade-off among diverse impacts of FI and greater FI is not entirely beneficial. Medium amount of FI combined with high trade tends to yield more desirable outcomes.

The implication is that integrated policies are preferable. FI should be considered together with enhancing TI, reducing asymmetric frictions, improving unequal financial access, and advancing financial development. Deepening integration in both markets may be more favorable to business cycles than focusing at only FI. Everyone should be able to access and utilize saving, investment and borrowing opportunities. Moreover, a sound domestic financial market is an important support when FI is imperfect.