This Time Is Different: Financial Integration and the 2007 Crisis

We study how the 2007-2009 crisis has changed the impact of financial integration on the transmission of international business cycles, focusing on a sample of 20 developed countries between 1978 and 2009. We use a differences-in-differences strategy for identification and investigate the effect of bilateral financial linkages on the co-movement of output, investment, and consumption before and after the current crisis. We find that while the relationship between financial linkages and synchronization of output was negative before (increases in financial linkages were followed with divergent output cycles), this effect turns out to be positive during the recent crisis (more integrated countries now comove more). We then develop a simple model with multiple sources of fluctuations to interpret these findings. The model suggests that the shocks driving the current crisis are very different from those that drove business cycles in the earlier period. JEL Classification: E32, F15, F36