WP 20-01/R – Standard international transmission mechanism of productivity shocks predicts a weak endogenous linkage between trade and business cycle synchronization: a problem known as the trade-comovement puzzle.
Supersedes Working Paper 17-42 – Long-Run Trade Elasticity and the Trade-Comovement Puzzle. A previous version of this working paper was originally published in January 2020.
We provide the foundational analysis of the puzzle, pointing to three natural candidate resolutions: i) financial market frictions; ii) Greenwood–Hercowitz–Huffman preferences; and iii) dynamic trade elasticity that is low in the short run but high in the long run. We show the effects of each of these candidate resolutions analytically and evaluate them quantitatively. We find that, while i) and ii) fall short of the data, iii) goes a long way toward resolving the puzzle.