The contribution of domestic, regional and international factors to Latin America's business cycle

This paper quantifies the relative contribution of domestic, regional and international factors to the fluctuation of domestic output in six key Latin American (LA) countries: Argentina, Bolivia, Brazil, Chile, Mexico and Peru. Using quarterly data over the period 1980:1-2003:4, a multi-variate, multi-country time series model was estimated to study the economic interdependence among LA countries and, in addition, between each of them and the three world largest industrial economies: the US, the Euro Area and Japan. Falsifying a common suspicion, it is shown that the proportion of LA countries' domestic output variability explained by industrial countries' factors is modest. By contrast, domestic and regional factors account for the main share of output variability at all simulation horizons. The implications for the choice of the exchange rate regime are also discussed.     

International business cycles and the relative price of investment goods

Abstract Is the relative price of investment goods a good proxy for investment specific technology? We model this relative price in a flexible price international economy with two fundamental shocks, namely, the total factor productivity (TFP) shock and the investment‐specific technology (IST) shock. We show that the one‐to‐one correspondence between the IST shock and the relative price of investment goods breaks down in an international economy because of the short‐run correlation between the terms of trade and the relative price of investment goods. The data congruent negative correlation between the investment rate and the relative price of investment goods thus does not necessarily reflect decline in investment frictions (rise in IST), as suggested by many studies. A calibration experiment with the US data demonstrates that such an inverse relation between rate of investment and the relative price of investment goods basically reflects the positive effect of TFP on the terms of trade for a broad range of economies where the home bias in consumption exceeds investment and there is a sizable adjustment cost of investment.     

Investment-specific shocks and real business cycles in emerging economies: Evidence from Brazil

This paper investigates the role of the RBC (Real Business Cycle) model with investment-specific technology shocks in explaining business cycle fluctuations in Brazil. I consider the role of transitory and permanent components of neutral and investment-specific technology shocks. I fit the model to the data using Bayesian techniques to show that the investment-specific shocks are important sources of fluctuations in the estimated model. In fact, in the context of the model, investment-specific shocks can account for remarkable percentages of fluctuations in consumption growth, GDP growth, investment growth and trade balance to GDP ratio. Furthermore, I present simulation evidence showing that the RBC model cannot account for some important features of the data.     

Business cycles through international shocks: A structural investigation

This paper investigates the sources of output volatility by decomposing the international shocks into finance and trade shocks. Through structural Bayesian estimations of an open-economy DSGE model on 16 countries, on average, international shocks explain around 70% of output fluctuations.     

International transmission of the business cycle in a multi-sector model

Standard multi-country models do not replicate important features of the international transmission of business cycles, predicting cross-country correlations of output and consumption which are, respectively, too low and too high. In this paper we modify the supply side of a two-country model by adding multiple sectors and trade in intermediate goods. The model generates a higher cross-country correlation of output than standard one-sector models. It also predicts cross-country correlations of employment and investment that are closer to the data. We analyze the relative impact of multiple sectors, trade in intermediate goods, imperfect substitution between domestic and foreign goods, home preference, capital adjustment costs, and capital depreciation in order to pinpoint the features which move the model's predictions closer to the data.     

Financial market participation and the developing country business cycle

I explore the implications of limited participation in financial markets on a standard small open economy business cycle model. Despite its parsimony, the limited participation model developed in this paper improves over the standard model in terms of explaining two important features of business cycle facts of developing countries: high volatility of consumption, and high negative correlation between the trade balance and output. Limited participation model is then used to inspect the effects of financial development and integration on macroeconomic volatility. Under a standard calibration, limited participation model leads to the conclusion that financial development and integration are associated with higher investment and output volatility. Effect of more participation on consumption volatility is dependent on the specification of the risk premium function.     

Expectation driven business cycles with limited enforcement

We explore shocks to expected future productivity in a model with limited enforcement of financial contracts. A microfounded collateral constraint implies that good news about future productivity yield an increase in stock prices, available credit and a general economic expansion.     

Investment-specific shocks and external balances in a small open economy model

Abstract.  We set up a standard small open economy business cycle model driven by government spending shocks, neutral productivity (TFP) shocks, and investment-specific shocks. The model is calibrated to quarterly Canadian data and its predicted moments and sample paths are compared with their Canadian counterparts. We find that the model captures the dynamics in investment and in the trade balance better than special cases of the model where either one of the productivity shocks is omitted. More specifically, the model matches the variance of the trade balance-output ratio, its correlation with output and its autocorrelation. It also matches the output-investment correlation.     

A dynamic small open economy model with involuntary unemployment

Abstract It is well known that real business cycle small open economy (SOE) models rely on Greenwood, Hercowitz, and Huffman (1988) preferences to match the countercyclical trade balance observed in open economies, as well as other second moments, while standard preferences à la King, Plosser, and Rebelo (1988) are commonly labelled ‘ineffective,’ owing to their inability to yield the countercyclical trade balance. In this paper, I show that an SOE model with standard preferences and ‘involuntary’ unemployment with efficient risk sharing can obtain a countercyclical trade balance and match main empirical regularities in small open economies.     

Trend shocks and the countercyclical U.S. current account

From 1960 to 2009, the U.S. current account balance has tended to decline during expansions and improve in recessions. We argue that shocks to the trend growth rate of productivity can help explain the countercyclical U.S. current account. Our framework is a two‐country, two‐good business cycle model in which international asset trade is limited to a single, non‐contingent bond. We identify trend and transitory shocks to U.S. productivity using generalized method of moments (GMM) estimation. The specification that best matches the data assigns a large role to trend shocks. The estimated model also captures key facts regarding international co‐movement.     

External Imbalances and the Extensive Margin of Trade

We quantify the role of the extensive margin in the recent trade dynamics of selected countries that are running large and persistent trade imbalances. We find that the role of the extensive margin is quite substantial, although it varies in significance across the countries in the sample. Finally, we highlight differences in behaviour between the fixed‐varieties and varieties‐adjusted terms of trade.     

Capital mobility,openness, and saving-investment relationship in Asia

The main objective of this paper is to investigate the relationship between openness to trade and saving-investment behaviour in Asia during the period 1990–2006. We use this relationship to examine whether those Asian countries that are more open to trade and enjoy less trade barriers have also higher degree of capital mobility. Cluster analysis is used to classify the countries into different groups according to the share of trade in their gross domestic products and their average tariff rates. The goal is to place the countries that are similar to each other in terms of their trade policy in one group. We apply the Generalized Least Square (GLS) technique to a set of balanced panel error correction models to estimate the short- and long-run relationship between saving and investment. The estimation results indicate that there exist long-run equilibrium relationships between domestic saving and investment in all groups regardless of their degree of trade openness. Moreover, contrary to Amirkhalkhali and Dar (2007) for the case of OECD, we find out that more openness in terms of trade policy is associated with higher degree of capital mobility for the case of Asian countries. One policy implication of this result for the Asian economies is that trade openness can be used as a strategy to attract capital from abroad. Our findings also confirm the prediction of new open economy macroeconomic models regarding the short- and long-run behaviour of current account.     

On the role of money in a business cycle model of a small open economy: The case of Spain

This paper examines the consequences of introducing a cash-in-advance constraint into a small open economy business cycle model for the Spanish case. A business cycle model is built extending Correia, Neves and Rebelo's (1995) small open economy framework and Cooley and Hansen's (1995) monetary economy. Money is introduced through a cash-in-advance constraint. The stochastic simulation of the model and its comparison to Spanish data show that the model is able to mimic i) the Dolado et al. puzzle, that is, the high volatility of private consumption for this economy; ii) the Dunlop-Tarshis observation, i.e., the negative correlation between real wages and hours worked; and iii) some cyclical features of the nominal dimension.     

Macroeconomic dynamics in Macedonia and Slovakia: Structural estimation and comparison

This paper estimates a structural macroeconomic model using data for Macedonia and Slovakia to characterize possible challenges Macedonia can face concerning macroeconomic stabilization during its transition process. A comparison of the estimated model parameters suggests that, in Slovakia, the output gap is less sensitive to real interest rate movements and prices experience greater inertia. The estimated monetary policy reaction functions show Macedonia and Slovakia as inflation targeters, with Macedonia as the more conservative one, despite its officially applied exchange rate targeting regime. The differences in the estimated parameters imply differing transmission mechanisms for Macedonia and Slovakia. Consequently, the variance of domestic variables in Slovakia is most influenced by monetary policy shocks, while there is no single dominating shock explaining the volatility of Macedonia's macroeconomic variables. The exchange rate shock, the monetary policy shock and the demand shock are jointly important in determining the volatility of Macedonia's variables. The model simulations indicate that Macedonia experiences lower output gap and inflation volatility than Slovakia. This comes, nevertheless, at the cost of higher interest rate and real exchange rate volatility in Macedonia, which could be an indication of more volatile financial markets with possible negative implications for financial stability.     

The business cycle implications of the euro adoption in Poland

This article analyses the macroeconomic impact of the loss of autonomous monetary policy after the euro adoption in Poland. Using a two-country Dynamic Stochastic General Equilibrium (DSGE) model with sticky prices and wages, we find that the euro adoption will have a noticeable impact on the magnitude of economic fluctuations. In particular, the volatility of output, interest rate, consumption and employment is expected to increase while the volatility of inflation should decrease. Also, in order to quantify the effect of the euro adoption, we compute the welfare effect of this monetary policy change. Our findings suggest that the welfare cost is not large.     

Trade and business cycle synchronization in OECD countries—A re-examination

This paper re-examines the relationship between trade intensity and business cycle synchronization for 21 OECD countries in the period 1970-2003. Instead of using instrumental variables, we estimate a multivariate model including variables capturing specialization and similarity of economic policies. We confirm that trade intensity affects synchronization, but the effect is much smaller than previously reported. Other factors, like specialization and convergence in monetary and fiscal policies, have a similar impact on business cycle synchronization as trade intensity. The effect of trade on synchronization is not driven by outliers. However, the impact of trade on synchronization is not robust across deciles.     

Do tax cuts generate twin deficits? A multi‐country analysis

Abstract We study the effects of tax shocks on the budget and external deficits for 16 industrialized countries over the post‐1970 period. Our structural approach is based on a small open economy model where a tax cut affects the external deficit by two distinct channels. The demographic channel works through the overlapping‐generation structure of the model. The forecasting channel works through the dynamic structure of the model. Our empirical analysis documents that tax shocks generate twin deficits, and that both channels play important roles in explaining the positive comovement between the budget and external deficits.     

Determining a Modified Currency Board's Two-Period Exchange Rate Strategy

Is it preferable for a modified currency board (MCB) to disguise its true characteristics and preferences and renege later? This paper analyzes a model in which a MCB determines its first-period exchange rate strategy to maximize a two-period welfare function. The inflation rate anchored by a classical currency board (CCB) is always a benchmark to the MCB in its first period decision. If the benchmark inflation rate is either sufficiently low or sufficiently high, the MCB chooses the optimal exchange rate in both periods without playing a credibility game over time. However, if the benchmark is at a moderate level, a strategy of overtly deceiving the public by pretending to be a CCB is shown to be superior to a strategy of concealing through policy randomization.     

Earnings inequality and the business cycle

Economists have long viewed recessions as contributing to increasing inequality. However, this conclusion is largely based on data from a period in which inequality was increasing over time. This paper examines the connection between long-run trends and cyclical variation in earnings inequality. We develop a model in which cyclical and trend inequality are related, and find that in our model, recessions tend to amplify long-run trends, i.e. they involve more rapidly increasing inequality when long-run inequality is increasing, and more rapidly decreasing inequality when long-run inequality is decreasing. In support of this prediction, we present evidence that during the first half of the 20th century, when earnings inequality was generally declining, earnings disparities indeed appeared to fall more rapidly in downturns, at least among workers at the top of the earnings distribution.     

Measuring business cycles: Empirical Mode Decomposition of economic time series

This paper continues discussion on the issue of time series decomposition by presentation of the Empirical Mode Decomposition technique. This technique outperforms well-known time-series filters by providing a deeper insight into the structure of time series.