The Dynamics of Permanent and Transitory Components in International Business Cycles

The paper investigates the dynamics of permanent and transitory components that are common across seven developed nations of the world. The common components are modeled to exhibit different behavior in the expansion and recession phases of international business cycles. I employ a multivariate unobserved components model with Markov regime switching to measure the common components of international time series. The model is estimated in its state-space representation by applying the Kalman filter and Kim’s (1994) approximate maximum likelihood algorithm. I find that, in contrast to individual country’s business cycles, the international business cycle does not exhibit classical contraction and expansion phases. The international permanent component has two phases: a high-growth phase and a low-growth phase, and there is no evidence of an international transitory component. I find that the switch from a high-growth regime to a low-growth regime occurs in the second quarter of 1973. There are no further switches that occur from one regime to another. I also find that among the seven developed nations examined, Japan is the most sensitive and Germany is the least sensitive to international permanent shocks.