Professor to Study the Effects of an Integrated World Economy

Christopher Otrok, Sam B. Cook Chair in Economics, has received support from the National Science Foundation (NSF) to study how financial disturbances, or shocks, felt in one country impact other nations in today’s integrated world economy. The grant is titled, “Macro-Financial Linkages in an Era of Globalization.”

“These shocks could have their origins either in the policy actions of national governments or as outcomes of market forces,” says Otrok. “The implications of these shocks for business cycle co-movement across countries are of considerable interest from both an analytical and policy perspective.”

The global economic landscape started seeing changes, such as cross-border trade, financial flows, and the rising prominence of emerging market economics, in the mid-1980s. Recent global financial crises have highlighted the linkages across financial markets and world economies.

“The United States’ 2008 economic crisis spread to Europe and eventually became a global problem,” says Otrok.

His project will address two issues concerning macro-financial linkages, which refers to the close ties between variables such as gross domestic product and employment, and stock market indexes and interest rates.

What are the implications of rising macro-financial linkages for the synchronization of business and financial cycles? And are common shocks or the propagation of country-specific shocks the key to synchronicity of business and financial cycles across countries?

To address these questions, Otrok will develop an econometric model that will capture different aspects of international business cycle co-movement and will differentiate between true shocks and their propagation effects. The model will be used to study the roles of financial shocks and their spillovers in driving business cycle movement of real macroeconomic aggregates.

“The project will transform the growing debate on the implications of globalization with new evidence on how this phenomenon has affected the nature of cross-country economic and financial relationships,” says Otrok.

The research results can provide guidance for policymakers in evaluating the propagation channels for major shocks that originate in one country but affect others. Once the model is in place, Otrok can look at how to predict the effects of shocks, and how to adjust for them to make them less devastating. This will be essential for designing effective stabilization policies at the national level and for coordination of policies at the international level.

By Laura Lindsey, College of Arts and Science
August 1, 2012