International capital movements and the locomotive effect

In this paper, we build a two-country, two-good model in which domestic and foreign investment goods are perfect or imperfect substitutes and the utilization rate of capital is variable. If investment goods are imperfect substitutes the model succeeds in mimicking the output cross-country correlation. In particular, a country-specific technological shock leads to an increase in output in the two countries, which reveals a locomotive effect. Thus substitution elasticity between domestic and foreign investment goods is a key parameter of the international transmission of the business cycle in the model.