“By Force of Demand: Explaining Cyclical Fluctuations of International Trade and Government Spending”

Mingming Jiang, Shandong University

This paper explores the role of demand shocks, as an alternative to productivity shocks, in driving both domestic and international business cycles within the international real business cycle (IRBC) framework. In addition to those well-documented domestic business cycle fluctuations (e.g., the volatility and cyclicality of output, consumption, investment, labor hours, and labor productivity) and international business cycle properties (e.g., the countercyclical net export, the comovement puzzle, and the Backus-Smith puzzle), this paper focuses on two additional stylized facts in the industrialized countries: the procyclical trade openness (the GDP fraction of trade volume) and the countercyclical government size (the GDP fraction of government spending). Using a parsimonious dynamic stochastic gen- eral equilibrium model, we show that the model's predictions under productivity shocks are not consistent with these facts. Instead, a demand-shock-driven model replicates the above facts while matching other domestic and international business cycle properties.