International Business Cycles Under Fixed and Flexible Exchange Rate Regimes

Abstract

This paper studies the changing characteristics of post-war international comovement under fixed and flexible exchange regimes. I find that business cycle comovement among all the G7 economies was highest in the universally flexible exchange rate era following the collapse of Bretton Woods (BW) and before the Basle-Nyborg agreement tightened the bands governing the European Exchange Rate Mechanism (ERM). With the exception of a few examples (Canada/US and Germany/France) G7 business cycles were far less synchronized in the universally fixed exchange rate BW era. More recently the ERM period in which continental Europe maintained fixed exchange rates, is characterized by a high degree of comovement among continental Europe and the English-speaking G7 countries, with little synchronization across these groups. I find that these changing patterns of comovement were driven by changes in the propagation of shocks rather changes in the relative volatility of shocks themselves across these time periods.