Searching for the source of macroeconomic integration across advanced economies

This article estimates a two-country open economy DSGE model by using US and euro area data. The baseline model, where the two regions are linked only through the trade of goods and risk-free bonds, fails to replicate the high cross-regional macroeconomic correlation in the data. I search for the determinants of this correlation by reconfiguring the model’s shock processes in two ways. First, I include shocks that symmetrically affect each region. Second I allow for the transmission of shocks between the two regions. Whilst both of these changes considerably improve the model’s performance along the international dimension, common shocks appear to be the main drivers of cross-regional correlation. Under both specifications, comovements of variables are mostly determined by demand and financial shocks. Productivity, cost-push, and exchange rate shocks, by contrast, play a limited role.