The Japanese economy has been hit hard by the slump in global demand for advanced manufacturing products such as cars, information technology, and machinery, which account for a larger share of production than in other G-7 economies. Most of the drop in Japan’s exports was caused by a sharp retrenchment in overseas demand for motor vehicles, information technology, and capital goods, as firms and consumers cut their investment and durable goods spending in response to the global credit crunch and extraordinary uncertainties about the outlook. Worsening domestic financial conditions deepened the current recession by reducing domestic demand, especially business investment. The short-term outlook is further clouded by the needed adjustment to inventories, which have accumulated well above normal levels in both Japan and its export markets. During the 2001 recession, industrial production started recovering about 5 months after the peak of the inventory cycle. By analogy, one could expect a bottom in industrial production around May 2009. However, since the global environment is expected to remain weak and the Japanese economy faces headwinds from tight domestic financial conditions, the production adjustment could take longer during this recession.
This paper develops an aggregation procedure using time-varying weights for constructing the common component of international economic fluctuations. The methodology for deriving time-varying weights is based on some stylized features of the data documented in the paper. The model allows for a unified treatment of cyclical and seasonal fluctuations and also captures the dynamic propagation of shocks across countries. Correlations of individual country fluctuations with the common component provide evidence of a “world business cycle” and a distinct European common component. The results suggest that macroeconomic fluctuations have become more closely linked across industrial economies in the post–Bretton Woods period.