Effects of bilateral trade intensity and economic development on business cycle synchronization

The economists in their research have documented that the economic activity of some economies are booming and falling into recession at roughly the same time while others are booming and recessing at completely different times. However, one could go even further and determine what kind of factors will lead to business cycle synchronization.; This paper focuses on investigating the impact of bilateral trade intensity and similarity of economic development on business cycle synchronization. Although at least two articles have been published on bilateral trade intensity (using a different dataset), there is no literature that links economic development similarity and business cycle correlation.; The dataset used in this research includes quarterly and annual unbalanced panel data from 1975 to 2004 for over 60 countries. The research unambiguously concludes that when economic development between countries is similar they will tend to fluctuate together. The findings also include that intra-industry trade significantly dominates intra-industry trade and therefore trade intensity has positive effect on business cycle synchronization.; Thus the true costs of joining a monetary union might be overestimated due to convergence and increased trade after joining a monetary union. Note that these findings may have implications to the coordination of fiscal policy between countries, financial portfolio management as well as the help in the discussion of which currency regime to choose: free float or a fix.