The Impact of Financial and Trade Integration on Business Cycles in Emerging Markets

Abstract

This paper investigates the combined effect of financial integration (FI) and trade integration (TI) on macroeconomic volatility and business cycle synchronisation (BCS) in emerging markets. The study adopts a two-country real business cycle model with the adjustment cost of foreign asset holding, domestic leverage constraint and asymmetric financial accessibility. The results reveal that the impacts of FI and TI are intertwined. Increasing foreign asset holding generally has a weaker impact at high trade intensity. People with restricted financial access face large consumption volatility from increased FI under low trade. The findings suggest that trade could help mitigate the negative effect of FI on consumption smoothing, and FI could help lower output fluctuation and dependence on foreign economies, while trade increases them.