Real Interest Rates and Productivity Shocks : Why Are Business Cycles Negatively Correlated Between the European Union and Jordan?

Why is there a negative correlation between business cycles in Jordan and the EU15? This paper explores the hypothesis that total factor productivity (TFP) increases in Europe spill over to Jordan only if embodied in foreign direct investment, but that European TFP growth negatively affects the Jordanian economy through higher world interest rates. This unambiguously lowers Tobin's q and has a negative income effect if net foreign asset holdings are negative. A dynamic stochastic equilibrium business cycle model is used to quantify the importance of this transmission channel. Simulations with observed exogenous impulses suggest a reasonably good performance of the model economy, but real interest rate shocks alone are too weak to account for the negative correlation. However, in conjunction with oil price-related shocks to transfers and the government share, the puzzle may be resolved.