How does international trade impact business cycles?

1 Trade and business cycle phases

The phases of a business cycle are expansion, peak, contraction, and trough. Trade can affect each phase by changing the demand and supply of goods and services, as well as the prices and incomes of producers and consumers. For example, during an expansion, a country can benefit from exporting more to other countries that are also growing, or importing cheaper inputs from other countries that are facing lower demand. This can boost the domestic output and employment, and increase the income and spending of households and firms. However, during a contraction, a country can suffer from lower export revenues or higher import costs, as other countries reduce their demand or increase their prices. This can reduce the domestic output and employment, and decrease the income and spending of households and firms.

3 Trade and business cycle transmission

The transmission of business cycles refers to the process by which economic fluctuations spread from one country to another. Trade can affect the transmission of business cycles by creating channels and mechanisms for transmitting shocks across borders. For example, a negative shock in one country, such as a natural disaster or a financial crisis, can reduce its demand for imports from other countries, or increase its supply of exports to other countries. This can cause a negative shock in the other countries, as they face lower export revenues or higher import competition. Alternatively, a positive shock in one country, such as a technological innovation or a policy stimulus, can increase its demand for imports from other countries, or decrease its supply of exports to other countries. This can cause a positive shock in the other countries, as they enjoy higher export revenues or lower import competition.

4 Trade and economic policy

The impact of international trade on business cycles has important implications for economic policy. On one hand, trade can enhance the efficiency and welfare of countries by allowing them to specialize and exchange according to their comparative advantages. Trade can also provide opportunities for diversification and risk-sharing, as countries can access a wider range of markets and products. On the other hand, trade can expose countries to external shocks and volatility, as they become more interdependent and sensitive to the conditions and policies of other countries. Trade can also create challenges for coordination and cooperation, as countries may have conflicting or inconsistent objectives and interests. Therefore, countries need to design and implement appropriate policies to maximize the benefits and minimize the costs of trade, such as trade liberalization, exchange rate management, fiscal and monetary policy, and regional and multilateral cooperation.

5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?