No Economic System Is Safe. Shocks Travel Quickly and Unexpectedly
A global economy is exposed to the spread of disturbances from one market to others. One might think that this kind of pass-through mainly works in one direction: from bigger countries to smaller countries. Max Mariano Croce, Riccardo Colacito, Yang Liu and Ivan Shaliastovich found that it is usually the other way round: shocks are more easily transmitted from smaller countries to bigger countries.
Focusing on the international propagation of output volatility shocks to consumption, equity prices, and currencies, the authors compared a volatility index that takes into account the difference between actual and estimated GDP to macroeconomic data from 1971 to 2013 for 17 major industrialized countries. These were divided into G7 countries (Canada, France, Germany , Japan, Italy, United Kingdom, United States) and other G17 countries (Australia, Belgium, Denmark, Norway, New Zealand, the Netherlands, Portugal, Spain, Sweden, Switzerland).
"The average consumption pass-through is 50%, meaning that a 1% increase in output volatility in country A increases consumption volatility in country B by 0.5%", professor Croce says. The average pass-through rises to 70% for shocks originating in small countries. How does it happen? "Trading financial derivatives helps smaller countries to increase their export-to-output ratio. The local output volatility shock spills over to the other country". Due to financial integration, the effect is even greater on stock markets: the equity volatility pass-through is 90%. "We also found that the volatility of consumption differentials and the volatility of exchange rates are disconnected".
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