The effects of financial integration during crises

Abstract

We investigate the role of financial integration in the spread of the 2008 global financial crisis. Using a rich dataset covering 31 countries between 1978 and 2018, we find that during the 2008 financial crisis, when two countries have a higher level of financial integration, their consumption cycles are more synchronized. Similar patterns are found for investment and output. However, we also find that during times outside of the 2008 financial crisis, higher financial integration leads to more divergent consumption and output cycles. We build a two-country model with global banks and variable capital utilization to illustrate that the impact of financial integration on business cycle synchronization depends on the type of shock and that variable capital utilization is the key to accounting for the relationship between financial integration and investment synchronization. The calibrated model replicates our empirical findings reasonably well. Finally, our welfare analysis indicates that financial integration leads to welfare losses during financial crises but to welfare gains outside of financial crises.