Determinants of world business cycles: Some insights from a flexible dynamic factor model

Using a dynamic factor model, we characterize the business cycles co-movement among a panel of countries using a world factor, a country-specific factor, and an idiosyncratic component. We allow correlated factors and then study the contribution of each type of factor to the business cycle dynamics. We find that three world factors are necessary to characterize the co-movement on the world level. Our analysis shows that the three world factors correspond to the price dynamics, the consumption dynamics, and the GDP growth dynamics respectively. We then compare the importance of the world factor with that of the spill-over effects from the country-specific factor. Then we study how these factors are related to country shocks as well as other economic variables. Our data set covers 23 countries, which include the G7, Four Little Dragons (except Taiwan), Four Little Tigers (except Indonesia), and large developing economies such as India and China, covering more than 75% of world total output.