Understanding OECD Output Correlations

This paper develops an empirical model of the cross-country variation in bilateral output growth correlations for 17 OECD countries. Consideration is given to the role played by explicit mechanisms for transmitting shocks between countries, such as trade in goods and financial assets and the coordination of monetary policy between countries. In addition we identify a number of country characteristics and institutions (including measures of legal origin, accounting standards, and the speed of take-up of new technology) that appear to lead countries to respond similarly to economic shocks. Both transmission mechanisms and common country characteristics have a role to play in explaining output correlations. When we use our empirical results to help to explain the strong correlation observed between Australian and US output growth, we conclude that trade between the two countries is not sufficiently important to account for much of the correlation. Nor does the similarity of monetary policies make much of a contribution. Our results instead suggest that it is the similarity of economic characteristics and institutions that explains much of the observed correlation between Australian and US output growth.