Real Business Cycles in Emerging Countries?

Real Business Cycles in Emerging Countries? Javier García-Cicco, Roberto Pancrazi and Martín Uribe Published in American Economic Review (2010) Presented by Onursal Bağırgan Real Business Cycles in Emerging Countries? 09.02.2016 1 / 23

Background Information Business cycles in emerging countries explained using neoclassical model with shocks to total factor productivity no distortions Related Literature Kydland and Zarazaga (2002): RBC can replicate lost decade of 1980 s Argentina. Aguiar and Gopinath (2007): RBC with permanent productivity shocks can explain business cycles in emerging countries. Drawback of existing studies: Usage of short sample Real Business Cycles in Emerging Countries? 09.02.2016 2 / 23

Introduction A theoretical model and econometric estimation of the parameters A small open economy RBC model Argentina and Mexico Period: 1900-2005 Main finding: RBC model does a poor job at explaining several aspects of data Real Business Cycles in Emerging Countries? 09.02.2016 3 / 23

Business Cycles in Emerging Countries: 1900-2005 Figure: Output Per Capita in Argentina and the United States: 1900-2005 Real Business Cycles in Emerging Countries? 09.02.2016 4 / 23

Business Cycles in Emerging Countries: 1900-2005 Figure: Business Cycles in Small Economies: 1900-2005 Real Business Cycles in Emerging Countries? 09.02.2016 5 / 23

Business Cycles in Emerging Countries: 1900-2005 Figure: The Autocorrelation Function of the Trade Balance-to-Output Ratio in Emerging Countries Real Business Cycles in Emerging Countries? 09.02.2016 6 / 23

The RBC Model max E 0 β t [C t θω 1 X t 1 ht ω ] 1 γ 1 t=0 1 γ s. to Y t = a t K α t (X t h t ) 1 α D t+1 1 + r t = D t Y t + C t + I t + φ 2 K t+1 = (1 δ)k t + I t ( ) lim E D t+j t j Π j s=0 (1 + r s) K 0, D 1 given 0 ( Kt+1 K t ) 2 g K t Real Business Cycles in Emerging Countries? 09.02.2016 7 / 23

The RBC Model Process of productivity shock a t : ln a t+1 = ρ a ln a t + ɛ a t+1; ɛ a t N(0, σ 2 a ) Productivity shock X t is nonstationary. g t X t X t 1 Process of g t : ln(g t+1 /g) = ρ g ln(g t /g) + ɛ g t+1 ; ɛg t N(0, σ 2 g ) Debt-elastic interest rate premium: ( ) r t = r + ψ e D t+1 /X t d 1 Real Business Cycles in Emerging Countries? 09.02.2016 8 / 23

Calibration: Argentina 1900-2005 Real Business Cycles in Emerging Countries? 09.02.2016 9 / 23

Estimation: Argentina 1900-2005 Real Business Cycles in Emerging Countries? 09.02.2016 10 / 23

Data-Model Comparison Trade Balance-to-Output Ratio Figure: The Predicted Autocorrelation Function of the Trade Balance-to-Output Ratio Real Business Cycles in Emerging Countries? 09.02.2016 11 / 23

Data-Model Comparison Second Moments Real Business Cycles in Emerging Countries? 09.02.2016 12 / 23

The Financial Frictions Model max E 0 ν t β t [C t θω 1 X t 1 ht ω ] 1 γ 1 t=0 1 γ s. to Y t = a t K α t (X t h t ) 1 α D t+1 1 + r t = D t Y t + C t + S t + I t + φ 2 K t+1 = (1 δ)k t + I t ( ) lim E D t+j t j Π j s=0 (1 + r s) K 0, D 1 given 0 ( Kt+1 K t ) 2 g K t Real Business Cycles in Emerging Countries? 09.02.2016 13 / 23

The Financial Frictions Model Additional Processes Process of preference shock ν t : ln ν t+1 = ρ ν ln ν t + ɛt+1; ν ɛt ν N(0, σν 2 ) Process of s t : ln(s t+1 /s) = ρ s ln(s t /s) + ɛt+1; s ɛt s N(0, σs 2 ) where s t S t X t 1 ( or it s a typo and s t S ) t S t 1 Real Business Cycles in Emerging Countries? 09.02.2016 14 / 23

The Financial Frictions Model Additional Processes Debt-elastic interest rate premium: ( ) r t = r + ψ e D t+1 /X t d 1 + ɛ µ t 1 1 where ln µ t+1 = ρ µ ln µ t + ɛ µ t+1 ; ɛµ t N(0, σ 2 µ) Real Business Cycles in Emerging Countries? 09.02.2016 15 / 23

Financial Frictions Model Estimation: Argentina 1900-2005 Real Business Cycles in Emerging Countries? 09.02.2016 16 / 23

Financial Frictions Model Data-Model Comparison Real Business Cycles in Emerging Countries? 09.02.2016 17 / 23

Financial Frictions Model Variance Decomposition Real Business Cycles in Emerging Countries? 09.02.2016 18 / 23

Financial Frictions Model Trade Balance-to-Output Ratio Figure: The Predicted Autocorrelation Function of the Trade Balance-to-Output Ratio Real Business Cycles in Emerging Countries? 09.02.2016 19 / 23

Case of Mexico The country which is used to test RBC models in emerging countries: Aguiar and Gopinath (2007) Again, data period: 1900-2005 GMM estimation instead of Bayesian Method Real Business Cycles in Emerging Countries? 09.02.2016 20 / 23

Mexico: 1900-2005 Relevant Statistics Real Business Cycles in Emerging Countries? 09.02.2016 21 / 23

Mexico: 1900-2005 Trade Balance-to-Output Ratio Figure: The Autocorrelation Function of the Trade Balance-to-Output Ratio Real Business Cycles in Emerging Countries? 09.02.2016 22 / 23

Conclusion RBC Model does a poor job at explaining Argentina and Mexico data Trade balance-to-output ratio Volatility of consumption growth compared to output growth Estimations show that permanent productivity shock is not dominant The model with financial frictions fits well to business cycle data for Argentina. Real Business Cycles in Emerging Countries? 09.02.2016 23 / 23