Synchronized sinking - Paul Krugman - Op-Ed Columnist - New York Times Blog

Synchronized sinking

So much for decoupling. I do, however, have a small gripe with this NYT article. It suggests that the linkages of international markets via exports and imports make a synchronized world business cycle inevitable. Actually, there's a problem with that. You can do international linkages quite easily in a simple Keynesian model, and economists have been doing that since 1952. But when you try to run the numbers, they're never big enough to explain the actual degree of synchronization. (A bit on that here.)

The truth is that the synchronization of the world business cycle is something of a mystery.

Basically, we have no clue why economies don't "decouple" more around the world when a major one (in this case the US) hits trouble.

But, even though we have no theoretical explanations that really pass the smell test, it remains the case that the "world economy" does seem to rise and fall somewhat in tandem. As such it's not realistic to expect the EU economy to be unaffected by events elsewhere.

Also, many European banks had bought/set up US divisions, where they lost lots of money. Some prominent banks in Europe are just the European division of US banks, who are weathering a big storm.

There's something about "at the margin" involved here too. One can maybe say "there is no credit crunch in France" but at the same time, there has been a change in the credit available to the economy and that has an effect at the margin. And the margin can easily take care of 0.5% of growth. Throw in a reduced market for exports in the US (and potentially, in knock on, China) and also the UK and that's probably another 0.5% off French growth.

If you add that back, you get 2.4 - 2.7% which is about as much as we expect from late stage industrial economies these days...