Technology Shocks: Novel Implications for International Business Cycles

This paper studies the effects of neutral and investment-specific technology shocks in a standard international business cycle model. When investment-specific shocks explain a large fraction of fluctuations, as recently suggested by the empirical literature, our theoretical framework can account quantitatively for 1) the negative correlation between real exchange rates and relative consumption (Backus-Smith puzzle) 2) the negative correlation between terms of trade and relative output and 3) the large volatility of the terms of trade and trade flows. The main insight of this exercise is that investment-specific technology shocks in a open economy generate effects similar to taste-shocks: they raise production and domestic prices together with an appreciation of the terms of trade and large inflows of foreign goods. Our findings entail a reconsideration of the international transmission of technology shocks: the reponse of international prices depends critically on the type of technology shocks.