Explain why the correlation of output growth between the U.S. and Europe declined in the late 1980s and 1990s, even though the countries became more economically interdependent. What do you expect will happen to the correlation in the future?
What will be an ideal response?
Earlier business cycles had been synchronized due to worldwide oil price shocks causing recessions. From the late 1980s on, recessions in the U.S. and Europe were caused by very different idiosyncratic events, not common shocks. As a result, correlation of output growth between the U.S. and Europe declined. In the future, common shocks may reemerge and lead to a higher correlation of output growth.
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