Productive Misallocation and International Transmission of Credit Shocks

ABSTRACT We study the role of international trade in cross‐country financial shock transmission using an equilibrium business cycle model calibrated to the United States and Canada. Heterogeneous firms have differing needs for external finance and face occasionally binding collateral constraints hindering their investments, while input–output linkages drive trade in final goods and intermediate inputs. Transmission of a U.S. financial shock recession into Canada's economy is qualitatively different from productivity shock transmission and asymmetric. We trace the first result to a unique investment channel operating through persistent trade balance adjustments and the second to differences in the two countries' exposure to trade.