Towards an Understanding of Australia’s Co-movement with Foreign Business Cycles

Abstract

This paper identifies two transmission mechanisms which might contribute to explaining the well-documented correlation between Australian and foreign business cycles. The first is through exports. We find that the US and Japan have a high output elasticity of demand for Australia’s exports. Consequently, their business cycles have a larger impact on Australia’s exports than that suggested by their market shares. The second mechanism is through the share market. Both the US and Australian share markets appear to have a significant impact on Australian activity. Evidence is also found that the responses of investment to the share market in the two countries are remarkably similar. Given that the share markets are highly correlated, the similarity in response lags may help to explain the correlation in business cycles.