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How important are terms-of-trade shocks?
Abstract
According to conventional wisdom, terms-of-trade shocks represent a major source of business cycles in emerging and poor countries. This view is largely based on the analysis of calibrated business-cycle models. We argue that the view that emerges from empirical SVAR models is strikingly different. We estimate country-specific SVARs using data from 38 countries and find that terms-of-trade shocks explain less than 10 percent of movements in aggregate activity. We then estimate key structural parameters of a three-sector business-cycle model country by country and find a disconnect between the importance assigned to terms-of-trade shocks by theoretical and SVAR models.
... In contrast, for the commodity importers, an increase in commodity prices has negative effects on economic performance. Standard open economy macro theory proposes that exogenous commodity price shocks have large impacts on commodity exporters and importers at macroeconomic level (see Fernández, Schmitt-Grohé, and Uribe 2017;Kose 2002;Schmitt-Grohé and Uribe 2018). However, the previous empirical studies are unable to provide a unanimous inference about the size of the impacts on different countries or on groups of countries, or on how to measure these shocks (based on commodity prices, or terms-of-trade values), what groups of commodities produce these shocks especially, or what econometric methods should be used in estimating the exposure. ...
... Previous inference about the significance of the commodity and standard terms of trade exposures is very heterogenous. Theoretical real business cycle models, which calibrate the impacts of standard and/or commodity terms of trade shocks on the macro variables propose that the commodity terms of trade shocks are the major source of economic fluctuations among the emerging and developing countries (see Aguiar and Gopinath 2007;Bidarkota and Crucini 2000;Broda 2004;Drechsel and Tenreyro 2018;Fernández, Schmitt-Grohé, and Uribe 2017;Fornero, Kirchner, and Yany 2016;Kose 2002;Mendoza 1997;Roch 2019;Schmitt-Grohé and Uribe 2018;Shousha 2016). In general, the results seem to be method dependent: For example, Schmitt-Grohé and Uribe (2018) have indicated that although the results may vary across countries, the terms of trade shocks would constitute only 10% of the macroeconomic fluctuations in the developing economics. ...
... Overall, many of these exposures are consistent with the other related studies cited earlier, e.g. see Schmitt-Grohé and Uribe (2018). ...
This paper provides novel evidence on commodity market exposure, i.e., the impacts of commodity price and terms of trade fluctuations on macro performance amongst 46 emerging and developing countries (EMDCs) in Africa, Asia and the Latin American and Caribbean (LAC) region. We estimate the exposure of six macroeconomic variables to the commodity prices and terms of trade. Our results indicate that in overall terms, there is a strong and statistically significant long run
relationship between the vector of analyzed world trade prices and macro variables in all EMDCs. However, based on the short-term reactions, only about 10% of the macroeconomic variation amongst the EMDCs is due to commodity market related exposures. Our results also indicate that the commodity market exposure is not unanimous across countries, amongst regions, or especially between measures of exposure.
... Households maximize their lifetime utility function subject to their budget constraints. Following the open economy DSGE literature [16][17][18], the household's preference function is non-separable with respect to consumption and labor, as follows: ...
... In this DSGE model, the production sector has three types of firms: non-tradable goods producing firms, tradable goods producing firms, and mining firms. The first two firms employ the Cobb-Douglas technology [18], whereas the mining firms' output is exogenously defined [5,8]. ...
In this study, we assess the effects of the structural shocks on the external debt sustainability in Mongolia, based on an estimated small open economy (SOE) dynamic stochastic general equilibrium (DSGE) model with the traded, the non-traded, and the mining sectors. The impulse response results show that the traded sector’s productivity shock, the commodity price shock, the mining output shock, and the foreign interest-rate shock have a decreasing effect on external debt accumulation in Mongolia, whereas the non-traded sector’s productivity shock, the household preference shock, and the government spending shock have an increasing effect on the same. Furthermore, we assess Mongolia’s external debt sustainability under the COVID−19 pandemic shock. Under our assumed pandemic scenario, Mongolia’s external debt will increase by 30% from its steady state over the next 10–28 quarters. Our recommended solution in this study is to develop the traded sector, instead of the mining sector, to maintain sustainability of the external debt and to decrease vulnerability of the economy.
... Surveys can be found in van der Ploeg 2011 and Frankel 2012. Other major topics in the literature include the contribution of terms-of-trade shocks to macroeconomic volatility (for example, Mendoza 1995 andSchmitt- Grohé andUribe 2015), the comovement between the commodity terms of trade and real exchange rate (for example, Chen andRogoff 2003 andCashin, Céspedes, andSahay 2004), the impact of natural resource discoveries on activity in the nonresource sector (Corden and Neary 1982;van Wijnbergen 1984avan Wijnbergen , 1984b, and the relationship between terms-of-trade movements and the cyclical component of output ( Céspedes and Velasco 2012). Chapter 1 of the October 2015 Fiscal Monitor discusses the optimal management of resource revenues, a topic that has also been the subject of a large literature (for example, IMF 2012). ...
... Surveys can be found in van der Ploeg 2011 and Frankel 2012. Other major topics in the literature include the contribution of terms-of-trade shocks to macroeconomic volatility (for example, Mendoza 1995 andSchmitt- Grohé andUribe 2015), the comovement between the commodity terms of trade and real exchange rate (for example, Chen andRogoff 2003 andCashin, Céspedes, andSahay 2004), the impact of natural resource discoveries on activity in the nonresource sector (Corden and Neary 1982;van Wijnbergen 1984avan Wijnbergen , 1984b, and the relationship between terms-of-trade movements and the cyclical component of output ( Céspedes and Velasco 2012). Chapter 1 of the October 2015 Fiscal Monitor discusses the optimal management of resource revenues, a topic that has also been the subject of a large literature (for example, IMF 2012). ...
Commodity prices have declined sharply over the past three years, and output growth has slowed considerably among those emerging market and developing economies that are net exporters of commodities. A critical question for policymakers in these countries is whether commodity windfall gains and losses influence potential output or merely trigger transient fluctuations of actual output around an unchanged trend for potential output. The analysis in this chapter suggests that both actual and potential output move together with the commodity terms of trade but that actual output comoves twice as strongly as potential output. The weak commodity price outlook is estimated to subtract almost 1 percentage point annually from the average rate of economic growth in commodity exporters over 2015-17 as compared with 2012-14. In exporters of energy commodities, the drag is estimated to be larger-about 2¼ percentage points on average over the same period. The projected drag on the growth of potential output is about one-third of that for actual output.
... For instance, Kose (2002), Drechsel and Tenreyro (2017), and Fernández, González and Rodriguez (2018) consider shocks in international prices determining tot, but these shocks do not have a proper economic interpretation (supply or demand). Mendoza (1995), Schmitt-Grohé and Uribe (2018) and Fernández, Schmitt-Grohé and Uribe (2017) treat tot as an exogenous variable subject to "terms of trade shock" 2 . Backus, Kehoe and Kydland (1994) and Senhadji (1998) are exceptions that allow the movements in the trade balance and in the terms of trade be determined endogenously in a general equilibrium set up. ...
... The Harberger-Laursen-Metzler and Obstfeld-Razin-Svensson (ORS) effects predict a better trade balance following an improvement in the terms of trade, with ORS emphasizing that a more persistent improvement in tot would result in a milder augment in the trade balance, since households would consume a larger fraction of the bonanza brought by the amelioration in relative prices compared to a more transitory shock 12 . The empirical work of Mendoza (1995), Schmitt-Grohé and Uribe (2018) report that in 38 countries, out of 51 researched, an appreciation in tot ameliorates the trade balance (in SVAR and DSGE models) following a shock directly applied to the exogenous AR(1) process of the terms of trade. We however encounter opposite results: an improvement in the Brazilian terms of trade is associated with a worsening in the trade balance. ...
... This research paper seeks to close this gap, using a FAVAR model which, unlike vector autoregressive models, allows the estimation of the dynamic responses of a large number of home variables to foreign shocks (Mumtaz and Surico, 2009). Moreover, it aims to provide an alternative to the disconnect between the theoretical and empirical models, as outlined by Schmitt-Grohé and Uribe (2015) and Aguirre (2011), who advise the application of another methodology that guarantees a better interpretation of data. ...
... In particular, we find a lower share for productivity and interest rate shocks thanFernandez and Gulan (2015), although we also consider terms of trade and demand shocks. We also find a share of variance explained by terms of trade shocks that is very close to the structural vector autoregression model estimated by Schmitt-Grohe andUribe (2018). The estimated share of the variances explained by interest rates shocks is in general smaller than those estimated byGarcia- Cicco et al. (2010), who use a different specification of the financial friction with a debt elastic country premium and a risk premium shock, without amplification mechanism from the financial accelerator(Fernandez and Gulan, 2015) ...
... Our approach uses economic growth as function of standard economic factors and can be contrasted to works on business cycles with very different results on the role of commodity prices in economic growth, such as Zeev et al. (2017) on a sample of Latin American countries in support of the hypothesis that terms-of-trade shocks are an important source of cyclical fluctuations. See also Fernández et al. (2018) and Schmitt-Grohé and Uribe (2018) for studies of emerging markets with business cycle perspectives. ...
This paper investigates nonlinear relationships between terms of trade volatility (totvol) and economic growth in 14 Latin American economies from 1997 to 2014. In the 2000s, Latin American countries experienced accelerated economic growth often attributed to commodity price booms. We split the sample into two regimes based on totvol thresholds determined by bootstrap techniques. Fixed-effects, instrumental variable and dynamic panel regressions address endogeneity in trade-growth, subject to traditional economic channels such as domestic investment, population growth, exchange rate, government size, and institutions. We find statistically significant thresholds and stronger trade-growth links during the 2000s commodity boom and in larger economies.
... This paper analyzes the transmission of commodity terms of trade (CToT) shocks in commodity-exporting countries and argues that commodity prices are a better measure of the terms of trade than aggregate indices of export and import unit values (the measure used in Schmitt-Grohe & Uribe, 2018). In particular, I analyze a sample of 22 commodity-exporting countries that are quite heterogenous with respect to their level of economic development, exchange rate regime, openness to trade, public debt levels, and fiscal/monetary frameworks. ...
This paper analyzes the macroeconomic adjustment in commodity-exporting countries to commodity price shocks. First, I estimate a heterogenous panel SVAR using data from 22 commodity-exporting economies spanning the period 1980–2017. I find that commodity terms of trade shocks are an important driver of business-cycle fluctuations: they explain around 30 percent of movements in output, contrary to the 10 percent found in recent studies. However, there is wide variation in the responses to a commodity terms of trade innovation across countries. Second, I use panel SVARs to study the role of various key country characteristics and economic policies in the macroeconomic response to these shocks. I find evidence that exchange rate flexibility, inflation targeting regimes and fiscal rules help insulate the economy from commodity price movements.
... In addition, and to get the distinct dimension of terms of trade, the most important wisdom in this case is that terms of trade changes and shocks represent a major source of business cycles in emerging and poor countries based on the analysis of calibrated business-cycle models, essentially this result is obtained by first estimating a process for the terms of trade and then feeding it to an equilibrium business cycle model to compute the variance of macroeconomic indicators of interest induced by this type of disturbance, then this variance is compared to the observed unconditional variance of the corresponding macroeconomic indicator to obtain the share of variance explained by terms-of-trade shocks, consistently, the most important distinct dimension is that more than 30% of the variance of output and other macroeconomic indicators is attributable to terms-of-trade shocks. 7 This paper specifically focuses on analyzing the co-integration and causality relationships between economic growth, terms of trade, gross fixed capital formation, labor force and trade openness for the period 1990-2017 in the case of Maghreb countries ( , on the other hand, the paper makes a contribution to existing literature by fill the gap of scarcity of the studies on TOT effect on the economic growth in Arabic countries, this paper we try to bridge this gap by using an econometric examination for the period 1990-2017, the remainder of this paper is structured as follows, section 2 is for literature review on terms of trade and economic growth relationship and the HLM effect, the relationship between TOT and economic growth in section 3, while methodology and data are discussed in section 4, section 5 presents the results of the econometric study, and finally section 6 concludes the paper. ...
This study investigates the direct impact of terms of trade on economic growth in Maghreb countries from 1990 to 2017, so as to be able to test the Harberger-Laursen-Metzler effect, using various econometric techniques for panel data analysis as the modern unit root test PSCADF (2006), the Pedroni and Kao tests for co-integration in addition to Westerlund (2007, 2008) test with bootstrap technique, and finally the Dumitrescu-Hurlin (2012) non-causality test, the results shows that there is no evidence of any co-integration relationship between the variables, and there is a small effect from the TOT index to economic growth whereas any increase in the TOT index by 10% causes an increase in GDP by 0.217%, the results also shows that there is no evidence of any causality from terms of trade to economic growth in contrast of a uni-directional causality running from terms of trade to trade openness, and for the Harberger-Laursen-Metzler effect (HLM effect) the results reveal a weak effect with economic growth and trade openness in Maghreb countries.
... Shousha (2016) estimates that innovations in real commodity export prices are responsible for 23 percent of movements in aggregate output in emerging economies. Schmitt-Grohé and Uribe (2015) estimate that terms-of-trade shocks explain approximately 10 percent of movements in aggregate activity in less developed and emerging economies while Fernandez et al. (2015) estimate a model that assigns to commodity shocks 42 percent of the variance in income. are less willing to increase lending to the government, which induces the government to rely more heavily on taxation to provide for expenditures. ...
... The vulnerability is a reaction of individual economies to changes in global market developments that are not under their control, i.e., terms of trade and demand shocks. The relationships between terms of trade shocks and economic volatility are broadly discussed among theoreticians like Kpodar et al. [16], Juvenal and Petrella [17] and Schmitt-Grohe and Uribe [18]. Policymakers on both levels-regional groupings like the EU as well as national member countries-should be able to respond to trade shocks in real-time. ...
The European Union (EU) is characterized by a high level of openness to trade, consequently increasing its member countries’ vulnerability to external shocks coming from the rapidly changing global environment. The paper’s objective was to compare and evaluate the factors of the EU agribusiness, its vulnerability and its measurement tools, and consequently to create subgroupings within EU member countries with different levels of vulnerability to exogenous shocks. The study hypothesized that the EU is not a homogenous unit regarding its trade sensitivity and vulnerability. It analyzed this phenomenon using data of recognized international institutions. Its method was a multi-criteria analysis with summative scaling. The assessment of the analysis was provided by the linear aggregation of 19 relevant vulnerability-influencing parameters, including climate change risk and political stability. The study results confirmed the hypothesis of the EU heterogeneity and identified four groups of member countries with different levels of the vulnerability to global shocks. It can improve an understanding of the agrarian sector position within the EU economy and a more precise re-formulation of its Common Agricultural Policy (CAP) priorities under the new conditions requiring the comprehensive resilience of the sector.
... This setting correctly results in 2.1% property tax revenue per GDP, in line with rates from the General Tax Administration. Capital depreciation rate is set to 0.10 to target capital per GDP equal to 1.2 annually based on Schmitt-Grohé and Uribe (2015). According to the World Bank, urban residential areas in Morocco are about 2.7% of all land areas and agricultural farms are about 68%. ...
This paper assesses the macroeconomic and welfare effects of fundamental tax reforms in an emerging/developing economy. We develop a dynamic general equilibrium model with structural and institutional characteristics of non-oil emerging and developing economies and apply the model to Morocco. The model's simulations suggest that tax reforms imply complex trade-off between growth, government revenue, and equity. A comprehensive approach associated with better targeted social programs, broadens the tax base, removes tax distorsions, better distributes the tax burden, and mitigates adverse distributional effects (that is improves welfare) by making the tax system more progressive and reducing inequalities. For Morocco, a comprehensive tax reform package would involve (i) reducing tax exemptions, (ii) a broader-based property tax, (iii) a lower corporate tax rate, (iv) aligning the VAT rate on exempted goods and services to the standard rates, and (v) a better targeted social safety net. The paper indicates that such a reform package is growth-friendly, broad-based, progressive and has implications for existing gender biases.
... Lastly, a related strand of literature focuses on the effects of terms-of-trade shocks on developing countries by assuming that such shocks are exogenous to small economies. While earlier studies generally find that termsof-trade shocks explain a large share of the variation in output (approximately 30%) (Mendoza 1995;Kose 2002), recent studies find that these shocks account for a much smaller share (approximately 10%) (Lubik and Teo 2005;Aguirre 2011;Schmitt-Grohe and Uribe 2015). 10 Our empirical methodology has the advantage of capturing two sources of exogenous terms-of-trade shocks originating from oil and food markets, allowing us to shed more light on how much of the variation in output is explained by these more exogenous components of terms-of-trade shocks. ...
The dramatic fluctuations in global food prices over the past two decades have generated significant concern about their destabilizing macroeconomic effects. While the pass-through effects of international food prices on domestic prices have been widely documented, these estimates have not taken into account reverse causality, omitted variable bias, or differences in sources of international food price fluctuations. We use sign restrictions to identify relevant demand and supply shocks that explain the volatility in global food prices. We quantify their dynamic effects on several components of food exporters’ and food importers’ domestic output, including household consumption, government consumption, investment, and net exports. Our findings reveal that identifying the sources of the shocks driving global food prices is crucial to evaluating their domestic effects. Expansions in global economic activity that increase global food prices stimulate the domestic output of both food-importing and food-exporting economies; however, disruptions in global food commodity markets that lead to rising real food prices have large contractionary effects for food importers due to deteriorating trade balances and falling household consumption. We also document that the adverse effects of unfavorable global food shocks on household consumption are greater for food-importing countries with relatively high shares of household food expenditures and large food trade deficits.
... In particular, we find a lower share for productivity and interest rate shocks thanFernandez and Gulan (2015), although we also consider terms of trade and demand shocks. We also find a share of variance explained by terms of trade shocks that is very close to the structural vector autoregression model estimated by Schmitt-Grohe andUribe (2018). The estimated share of the variances explained by interest rates shocks is in general smaller than those estimated byGarcia- Cicco et al. (2010), who use a different specification of the financial friction with a debt elastic country premium and a risk premium shock, without amplification mechanism from the financial accelerator(Fernandez and Gulan, 2015) ...
This paper considers a modification of the standard Susceptible-Infected-Recovered (SIR) model of epidemic that allows for different degrees of compulsory as well as voluntary social distancing. It is shown that the fraction of population that self-isolates varies with the perceived probability of contracting the disease. Implications of social distancing both on the epidemic and recession curves are investigated and their trade off is simulated under a number of different social distancing and economic participation scenarios. We show that mandating social distancing is very effective at flattening the epidemic curve, but is costly in terms of employment loss. However, if targeted towards individuals most likely to spread the infection, the employment loss can be somewhat reduced. We also show that voluntary self-isolation driven by individual's perceived
risk of becoming infected kicks in only towards the peak of the epidemic and has little or no impact on flattening the epidemic curve. Using available statistics and correcting for measurement errors, we estimate the rate of exposure to COVID-19 for 21 Chinese provinces and a selected number of countries. The exposure rates are generally small, but vary considerably between Hubei and other Chinese provinces as well as across countries. Strikingly, the exposure rate in Hubei province is around 40 times larger than the rates for other Chinese provinces, with the exposure rates for some European countries being 3-5 times larger than Hubei (the epicenter of the epidemic). The paper also provides country-specific estimates of the recovery rate, showing it to be about 21 days (a week longer than the 14 days typically assumed), and relatively homogeneous across Chinese provinces and for a selected number of countries.
... In particular, we find a lower share for productivity and interest rate shocks thanFernandez and Gulan (2015), although we also consider terms of trade and demand shocks. We also find a share of variance explained by terms of trade shocks that is very close to the structural vector autoregression model estimated by Schmitt-Grohe andUribe (2018). The estimated share of the variances explained by interest rates shocks is in general smaller than those estimated byGarcia- Cicco et al. (2010), who use a different specification of the financial friction with a debt elastic country premium and a risk premium shock, without amplification mechanism from the financial accelerator(Fernandez and Gulan, 2015) ...
We estimate a workhorse DSGE model with an occasionally binding borrowing constraint.
First, we propose a new specification of the occasionally binding constraint, where the transition between the unconstrained and constrained states is a stochastic function of the leverage level and the constraint multiplier. This specification maps into an endogenous regime-switching model. Second, we develop a general perturbation method for the solution of such a model. Third, we estimate the model with Bayesian methods to fit Mexico's business cycle and financial crisis history since 1981. The estimated model fits the data well, identifying three crisis episodes of varying duration and intensity: the Debt Crisis in the early-1980s, the Peso Crisis in the mid-1990s, and the Global Financial Crisis in the late-2000s. The crisis episodes generated by the estimated model display sluggish and long-lasting build-up and stagnation phases driven by plausible combinations of shocks. Different sets of shocks explain different variables over the business cycle and the three historical episodes of sudden stops identified.
... Several studies propose modeling the characteristics of international complex networks [7,8]. In References [9,10], the authors study the trade frictions between rich and poor countries and identify the main topological features that are responsible for the difference between rich and poor countries in the international trade network. ...
The Belt and Road initiative (BRI) was announced in 2013 by the Chinese government. Its goal is to promote the cooperation between European and Asian countries, as well as enhancing the trust between members and unifying the market. Since its creation, more and more developing countries are joining the initiative. Based on the geographical location characteristics of the countries in this initiative, we propose an improvement of a popular recommendation algorithm that includes geographic location information. This recommendation algorithm is able to make suitable recommendations of products for countries in the BRI. Then, Fitness and Complexity metrics are used to evaluate the impact of the recommendation results and measure the country’s competitiveness. The aim of this work is to provide countries’ insights on the ideal development direction. By following the recommendations, the countries can quickly increase their international competitiveness.
... On the other hand, research using SVAR modelling to consider the impact of shocks in a trade setting is still in its infancy. For example, Çakir and Kabundi (2013) investigate an export/import shock, Nordmeier et al. (2016) a trade liberalization shock, Du et al. (2017) a political relations shock, and, most recently, Schmitt-Grohé and Uribe (2018) consider a terms of trade shock. Schmitt-Grohé and Uribe (2018) focus on a group of emerging and poor countries and find that terms of trade shocks have a more limited impact on key macroeconomic indicators, than one would expect based on the findings from models with micro-foundations. ...
This paper uses a structural PVAR model to study the macroeconomic effects of trade disintegration among NAFTA members. The results reveal substantial asymmetric responses, showing that the US is the most affected economy from a sudden negative trade integration shock. Moreover, Canada and the US are found to be relatively more interconnected with each other compared to the Mexican economy. Our findings question the US decision to push for the renegotiation of the NAFTA agreement.
We study the effects of real exchange rate (RER) changes on trade flows considering the skill content and origin/destination of products in a North-South framework. The empirical analysis is based on bilateral trade flows in five product categories of technology-and-skill intensities between 172 countries during 1962-2012. Consistent with the development channel, we find that both the composition and direction of trade affect how exports respond to RER changes. We find that high-skill manufactures and primary goods are the least affected from RER depreciation and volatility. The strongest effects are found for medium-skill, low-skill and resource-intensive manufactures. We also show that these effects depend on the direction of trade. Southern exports are more sensitive to RER than Northern exports in all product categories except for primary goods. Regarding volatility, South-North exports are hurt the most while North-South the least. Also, South-South exports appear to be less sensitive to volatility in all product groups than South-North. Overall, this paper provides a synthesis of the recent neoclassical international trade literature with the heterodox development literature.
In this study, we use the co-movements approach to examine the role of permanent (common trend) and temporary (common cycle) shocks on per capita output, per capita consumption, and per capita investment in Peru, a small open commodity-based economy. Using quarterly data from 1993: Q1 to 2019: Q1, the effects of the temporary shocks are short-lived, and, on average, are a minor source of the variations of macro time series, over 10 quarters. This evidence suggests that the main source of per capita output and per capita consumption variations is the common trend shock which must be related to the 1990s reforms. Moreover, per capita output and per capita consumption are less responsive to unfavorable (favorable) common cycle shocks than per capita investment is. This outcome indicates that per capita investment has a much more volatile cycle than per capita private output and per capita consumption which is consistent with a previous empirical work.
This article presents new evidence on the economic links between Asia and Latin America. Estimates from a Bayesian vector autoregression model show that key macroeconomic variables of the Pacific Alliance countries (Mexico, Peru, Chile, and Colombia) have a significant response to shocks on Emerging Asia’s demand. The spillover effects show that Peru is the country that is most vulnerable to income shocks in Emerging Asia. Nevertheless, developed economies’ shocks are still significant when it comes to explain the macroeconomic performances of Colombia, Chile, and especially, Mexico.
https://www.tandfonline.com/eprint/ZSTIZWGSQXTJKSRQZN7I/full?target=10.1080/1540496X.2019.1693362
We use 4-digit data to document the role of world shocks for intensive and extensive margin of exports. We estimate a VAR model, where the endogenous bloc comprises bilateral export margins and relative GDP, and the exogenous bloc comprises disaggregated measures of world price shocks. We find that world shocks have a significant impact on both the average export volume and export diversification. Impulse responses display considerable heterogeneity depending on the shock considered, the exchange rate regime and the great trade collapse. The evidence in the paper has remarkable consequences for trade and exchange rate policies.
This paper uses a structural PVAR model to study the macroeconomic effects of trade disintegration among NAFTA members. The results reveal substantial asymmetric responses, showing that the US is the most affected economy from a sudden negative trade integration shock. Moreover, Canada and the US are found to be relatively more interconnected with each other compared to the Mexican economy. Our findings question the US decision to push for the renegotiation of the NAFTA agreement.
The modern economy, which is a result of intricate human society, compels economists and policy makers to build complex economic models. In addition to this complexity, each country requires its own economic policies. This thesis addresses these intricacies of modern economies. In the first three chapters of this thesis, I improve the current literature to assess the role of financial intermediary agents, housing and credit markets in the economy, using Dynamic Stochastic General Equilibrium (DSGE) models. Data from three periods in the US economy, including the economic climate before the Great Rescission, the systemic collapse in 2008, and post-crisis fiscal policies, are imputed into the models. Simple DSGE models havebeen criticized for not placing more emphasis on financial frictions. Here, I have included financial frictions on different sides of economy to resolve the failures of previous models.The results of simulations indicate that introducing these features to the economy reveals new channels and mechanisms which are neglected in simple models. As a result, my model gives a more accurate means to forecast economic movements. In addition, this thesis documents the significance of macroprudential policy regulations in financial stability, sustainability and welfare. Lastly, in the final two chapters of my thesis, I move away from the study of advanced markets and focus on developing economies. These chapters build new models and address a variety of economic questions pertaining to financial, public and labor economics in developing countries, through the lens of multi-agent dynamic general equilibrium models. I examine the impacts of real, monetary, fiscal and oil price shocks on the economic environment of developing countries. I then propose appropriate policy recommendations.
We examine the impact of negative foreign output shocks, which entail negative demand side effects by lowering exports and positive supply side effects by lowering oil prices, on the welfare of non-oil producing, small open economies under five exchange rate and monetary policy regimes. We use a dynamic stochastic general equilibrium model with parameter values calibrated for Hong Kong, Israel, Singapore, South Korea and Taiwan. We find that welfare levels among the five policy regimes depend on the economy's share of oil imports in world oil consumption. Hong Kong, Singapore and Israel, which have smaller shares, maximize welfare under the Taylor rule, which targets both CPI inflation and real output. South Korea, with higher shares, and Taiwan, with more rigid prices, maximize welfare under real output targeting. CPI inflation targeting, nominal output growth targeting and fixed exchange rate regimes generate lower welfare. However, optimal monetary policy, which generates the highest welfare, gives greater weight on real output than CPI inflation.
This study reports a set of stylized facts about inflation-linked (IL) public debt in emerging economies. On average, emerging economies issue 23% of their local currency (LC) public debt linked to inflation. IL debt issuance is countercyclical, increases in periods of nominal exchange rate depreciations, and substitutes foreign currency (FC) and non-indexed local currency debt. A two-sector small-open economy model of public debt composition can deliver the business-cycle properties of IL debt and shows that, during crises, amid nominal exchange rate depreciations, IL debt becomes cheaper to issue. The study finds evidence of IL rates decreasing in about half of the most recent crises in emerging economies. Finally, the study compares IL rates to FC and LC rates and concludes that, for some countries, IL rates are below LC rates, even after accounting for expected inflation.
We show that a model of an advanced small open economy with exports in commodities and search and matching frictions in the labour market can match the impulse responses from a panel vector autoregression to an identified commodity price shock. Using a minimum distance strategy, we find that international financial risk sharing is low even for advanced small open economies. Moreover, a strong real exchange rate appreciation is key for an unexpected commodity price increase to induce a tightening of labour market conditions in the model that is in line with the empirical evidence. As in the case of technology shocks discussed by Shimer (2005), proper amplification of the commodity price shock requires a high value of the outside option for unemployed agents. However, vacancies and unemployment hardly respond whenever the real exchange rate channel is mute. These findings suggest the relevance of the open economy dimension for the transmission of demand-type shocks to the labour market more generally.
Leading into a debt crisis, interest rate spreads on sovereign debt rise before the economy experiences a decline in productivity, suggesting that news may play an important role in these episodes. The empirical evidence also shows that a news shock has a significantly larger contemporaneous impact on sovereign credit spreads than a comparable shock to labor productivity. We develop a quantitative model of news and sovereign debt default with endogenous maturity choice that generates impulse responses very similar to the empirical estimates. The model allows us to interpret the empirical evidence and to identify key parameters. We find that, first, the increase in sovereign yield spreads around a debt crisis episode is due mostly to the lower expected productivity following a bad news shock, and not to the borrowing choices of the government. Second, a shorter debt maturity increases the chance that bad news shocks trigger a debt crisis. Third, an increase in the precision of news allows the government to improve its debt maturity management, especially during periods of high financial stress, and thus face lower spreads and default risk while holding the amount of debt constant. JEL Classification: F34, F41, G15.
In several countries public finances are under pressure by pension obligations rising due to downward trends in fertility, increased longevity and financial markets with low interest rates. For these reasons, the establishment of Pension Reserve Funds (PRF) has flourished. Regardless of the specific objectives that these PRFs may have, a critical issue is to assess their sustainability over the long-run. Moreover, this sustainability analysis is particularly complex, due to the interaction between the macroeconomic environment, financial performance and the labor market.
In this article, we use a projection model aimed to evaluate the sustainability of the PRF in a small open economy such as Chile. The case of Chile is interesting because it shares common features with economies open to international markets that have either defined benefits pension schemes and/or defined contribution schemes with minimum pension guarantees. Moreover, since the Chilean PRF features relatively well defined contribution and withdrawal rules, we have a framework against which our methodology can be used to explore the effects on PRF's sustainability of altering these rules.
Our methodology takes into consideration the stochastic nature of macroeconomic, financial and labor market variables in order to evaluate the sustainability of the PRF. In contrast to deterministic measures such as funding ratios, our methodology is more appropriate to assess the role of the contribution and withdrawal rules for PRFs in evaluating the key underlying risks and their consequences for the sustainability of PRFs.
This paper investigates exchange rate pass-through into consumer prices by considering the nature of the shock triggering currency movements. By individually estimating structural factor-augmented vector autoregression models for 55 countries, monetary policy shocks are shown to be associated with higher exchange rate pass-through measures compared to other domestic shocks, while global shocks have widely different effects across countries. Pass-through measures tend to be lower in countries that combine flexible exchange rate regimes and credible inflation targets, where central bank independence can greatly facilitate the task of stabilizing inflation by using the exchange rate as a buffer against external shocks. It is implied that exchange rate pass-through should be investigated by considering the nature of the shock that triggers currency movements and country characteristics that affect the response of prices.
We study the macroeconomic consequences of a major trade disruption using the example of the Finnish–Soviet trade collapse in 1991. This is a rare case of a well–identified large trade shock in a developed economy. We find that the shock significantly affected Finnish output. Even so, the trade collapse was insufficient to generate an all–out crisis, and accounts for only a part of the Finnish Great Depression (1990–1993). We show that shocks originating domestically played a major role throughout the depression.
This research is aimed at contributing to the endogenization of default costs. Higher exposure of a banking system to sovereign bonds increases the likelihood of banking panics due to sovereign defaults. Following (Gertler, Kiyotaki, 2015), the research models the possibility of a banking crisis occurring after a sovereign default. While a higher exposure of a banking system is associated with potential losses, this mechanism creates a stronger commitment to honor the sovereign debt. A marginal increase in the sovereign debt raises the ex-post costs of default through a higher likelihood of a banking crisis, thus making a default option less desirable. This mechanism might increase investors’ confidence and resolve the coordination problem of self-fulfilling crises. In part, this may explain the findings of Bocola and Dovis (2019), who claim that non-fundamental risk played only a limited role during the European sovereign debt crisis. Furthermore, as opposed to the standard solution of the coordination problem — to issue debt of longer maturity — a government can resolve this problem by forcing its banking system to hold more sovereign bonds.
We build a new empirical model to estimate the global impact of an increase in the volatility of US monetary policy shocks. Specifically, we admit time-varying variances of local structural shocks from a stochastic volatility specification. By allowing for rich dynamic interaction between the endogenous variables and time-varying volatility in the global setting, we find that US interest rate uncertainty not only drives local output and inflation volatility, but also causes declines in output, inflation, and the interest rate. Moreover, we document strong global impacts, making the world move in a very synchronous way. Crucially, spillback effects are found to be significant even for the US economy. Globalization is a mixed blessing. The current heavy interdependence of countries has improved access to new markets and technologies, enabled knowledge sharing, and intensified flows of trade, capital, people, and ideas. However, it has also produced challenges. These include difficulties in regulating markets, tackling unintended effects spilling across economies, dealing with correlated shocks and synchronized business cycles, and making policy decisions in a highly uncertain environment. The role of monetary policy, especially after the global financial crisis, has been critical in stabilizing macroeconomic fluctuations. However, the effect on the real economy depends not only on central banks' actions but also on what agents expect them to do. Such uncertainty in the macroeconomic environment can be both a source and a byproduct of macroeconomic and policy developments. This effect can be further amplified by global financial and trade integration, thereby creating spillover and spillback effects. They matter not only for small open economies but also for large countries like the United States. By focusing on US monetary policy uncertainty shocks, this paper covers a global framework where unexpected variations in uncertainty about the US monetary policy impact the United States economy, which can, in turn, affect macroeconomic uncertainty, the global economy, and can even be imported back to the US. Specifically, we propose a new econometric model that extends the global vector autoregres-sive framework to estimate the global impacts of an increase in US monetary policy shocks' volatility. The model has two distinguishing features. First, we admit time-varying variances of local structural shocks from a stochastic volatility specification. Second, there is a dynamic interaction between the endogenous variables in the vector auto-regression and the time-varying volatility, allowing for the second-moment shocks' effects to the first-moment level. Because the model takes trade and financial linkages between economies into account, the uncertainty shocks affect the country of origin and spill over to other economies, whether connected directly or indirectly. We document how an unexpected change in the US interest rate volatility affects the US and the global economy. In line with the recent literature, we find a significant recessionary and deflationary effect, as well as increases in output and inflation volatilities. We also find strong spillovers, making the rest of the world move in a very synchronous way, especially among the advanced economies group. This contribution highlights the role of uncertainty in generating synchronized contraction and rationalizes the global economy's slow recovery. We document only marginally less pronounced spillovers (particularly for advanced economies) after the "great trade collapse', when we use trade weights, hinting at possible, though slowly moving, structural rebalancing in the global trade network. We find proof for US dominance globally once we instead employ financial linkages. Importantly, we establish that the global dimension is critical even for the US economy via the non-trivial spillback effects (thereby providing quantitative evidence of spillbacks from the global economy to the US economy). Additionally, we find that macroeconomic uncertainties are state-dependent and necessitate a dynamic interaction between endogenous variables and time-varying volatility. Specifically, a decrease in output growth leads to an increase in output and inflation volatility, thereby supporting recent findings in the literature that macroeconomic uncertainty is often a consequence of real economy fluctuations, whereas financially-related uncertainty is likely to be a cause.
When analyzing terms-of-trade shocks, it is implicitly assumed that the economy responds symmetrically to changes in export and import prices. Using a sample of developing countries our paper shows that this is not the case. We construct export and import price indices using commodity and manufacturing price data matched with trade shares and separately identify export price, import price, and global economic activity shocks using sign and narrative restrictions. Taken together, export and import price shocks account for around 40 percent of output fluctuations but export price shocks are, on average, twice as important as import price shocks for domestic business cycles.
Purpose
The primary purpose of this paper is to investigate the sources of the business cycle fluctuations in Vietnam. To this end, the author develops a small open economy New Keynesian dynamic stochastic general equilibrium (SOE-NK-DSGE) model. Accordingly, this model includes various features, such as habit consumption, staggered price, price indexation, incomplete exchange-rate pass-through (ERPT), the failures of the law of one price (LOOP) and the uncovered interest rate parity. It is then estimated by using the Bayesian technique and Vietnamese data 1999Q1–2017Q1. Based on the estimated model, this paper analyzes the sources of the business cycle fluctuations in this emerging economy. Indeed, this research paper is the first attempt at developing and estimating the SOE-NK-DSGE model with the Bayesian technique for Vietnam.
Design/methodology/approach
A SOE-NK-DSGE model—Bayesian estimation.
Findings
This paper analyzes the sources of the business cycle fluctuations in Vietnam.
Originality/value
This research paper is the first attempt at developing and estimating the SOE-NK-DSGE model with the Bayesian technique for Vietnam.
This article investigates the interplay between the exchange rate pressure (ERP), which is a proxy for export demand and foreign financial flows shocks, and fiscal redistribution in influencing poverty in developing countries. The analysis relies on an unbalanced panel dataset containing 90 developing countries over the period 1980–2014 and uses the two-step system GMM approach. Empirical results show that ERP influences positively poverty in developing countries, with the magnitude of this positive effect being the same for least developed countries (LDCs) and NonLDCs (countries not classified as LDCs in the sample). In addition, fiscal redistribution exerts a positive effect on poverty in developing countries, including in NonLDCs, but for LDCs, it leads to lower poverty rates. Interestingly, over the full sample, fiscal redistribution helps in reducing the magnitude of the positive effect of ERP on poverty. A further analysis has been performed by replacing ERP with a measure of terms-of-trade instability. Previous results are largely confirmed, with the exception that terms-of-trade instability exerts a higher positive effect on poverty in LDCs than in NonLDCs. Furthermore, while the positive poverty effect of terms-of-trade instability diminishes as the extent of fiscal redistribution rises, terms-of-trade instability leads to poverty reduction above a certain level of the extent of fiscal redistribution. Overall, these findings indicate that well-designed fiscal redistributive measures could help governments mitigate the adverse effects of external economic and financial shocks on poverty in developing countries.
This paper studies the evolution of China’s exchange rate policy using real options theory. With intervention costs and ongoing uncertainty, intervention involves the exercise of an option. Increased uncertainty increases the value of this option. This “wait and see” effect leads the Central Bank to widen its intervention band. However, increased volatility also produces larger fluctuations in welfare, which creates a “fear of floating.” This induces the Central Bank to set a tighter band. To study this trade-off, our paper incorporates stochastic volatility into a new Keynesian target zone model and then calibrates it to data from China. We find that increased uncertainty leads to a tighter intervention band, both in the data and in the model. Hence, in China, “fear of floating” appears to dominate the “wait and see” effect.
Commodity-rich economies share many common factors, which resulted in the generalization of any findings obtained from a single commodity-rich economy. This paper proposes a small open economy model for a commodity-rich country and studies the triggers of business cycles for four different commodity-rich economies to highlight the existence of heterogeneity among commodity-rich economies. The model introduces government consumption in a non-separable form to the utility function. Commodities have a central role in private consumption, production of final goods, and windfalls for the domestic government. We feed the model with a variety of shocks suggested by the previous literature. The estimations of the model show that oil-rich economies are more vulnerable to external shocks than their commodity-rich counterparts. The findings of the paper indicate that government spending is a significant source of heterogeneity. Also, given the relatively higher share of commodity rents when the principal commodity is oil, oil-rich countries need to adopt more prudential fiscal measures.
The Colombian economy has a strong dependence on the export of commodities. Different studies show that the prices of these products are exogenous, which have originated direct effects on the national economic activity. Therefore, this paper studies the shock effects produced by mining and energy commodity price variations like oil, coal and nickel on Colombian economy. We used 129 variables for 2001-2016 period and estimated a FAVAR model (Factor Augmented VAR) to observe commodity price effects on different economic aggregates, the results show that price fluctuations have significant effects on variables such as economic activity, investment, the trade balance, the real exchange rate and external debt.
The existing literature on panel models with interactive fixed effects have the common feature of modeling a univariate variable. In this regard, it is incapable of addressing dynamic and simultaneous interactions among a set of macroeconomic variables, which falls in the realm of structural analysis. This paper aims to contribute to the existing literature by studying a homogeneous panel vector autoregression (VAR) model with interactive fixed effects. The panel VAR model in question is flexible that it can accommodate an arbitrary lag length and observable regressors which can be individual specific or common. For factor VAR models with both a large cross-section (C) and a large time (T) dimensions, we derive the limiting distribution of the interactive-fixed estimator, allowing structural analysis to be extended to panel VAR models with interactive fixed effects.
La crisis económica alimentada por el Covid-19 ha producido choques de oferta y demanda que afectan al producto potencial y a las preferencias de los consumidores, impacto que sugiere que la tasa real neutral de interés se modificó y, por ende, la tasa real de interés debe ajustarse para no generar una contracción económica más profunda en México. Estimamos el valor de la tasa neutral utilizando el método de Laubach y Williams, basado en el filtro de Kalman, y confirmamos los resultados con un modelo cointegrado de vectores autorregresivos (CVAR). Los resultados muestran que la tasa real neutral, teóricamente congruente con el pleno empleo y la meta de inflación, se reduce hasta 0.1% y la nominal hasta 3.1%, lo que sugiere la existencia de suficiente espacio para una política monetaria expansiva que permita enfrentar la crisis e impulsar la actividad económica durante al menos tres años.
A feature of modern globalization processes is their vulnerability to the volatility of short-term capital flows, which, combined with the growing volatility of commodity prices, have created serious difficulties for the economic policies of commodity-oriented countries. Therefore, the study of the impact of world commodity prices on the dynamics of economic growth of countries with commodity exports and the development of an appropriate methodology based on modern economic and mathematical tools is an urgent task. The purpose of the study is the impact of volatility and the level of world commodity prices on income dynamics (GDP and industrial production) using three groups of countries with different levels of economic development as an example. Functional dependencies were studied for three groups of countries: industrial countries exporting raw materials, countries – commodity exporters of low income and commodity countries of the former Soviet Union. The analysis is based on quarterly data for the period 1980–2018 using the Two-Step Least Squares (2SLS) method. We developed a methodology for the economic and statistical analysis of the functional dependencies of the commodity economy, which provides for the simultaneous accounting of the level of world commodity prices and their volatility, allows us to empirically evaluate the mechanisms of the macroeconomic influence of commodity prices on the dynamics of economic growth, primarily income (GDP and industrial production). It has been established that rising world prices for raw materials improves the dynamics of GDP and industrial production of countries exporting primary resources, while the consequences of high volatility of price indices are predominantly negative. If the impact on the economic growth of the exporting countries of raw materials of individual price indices coincides, then the corresponding estimates for volatility can differ significantly.
Leading into a debt crisis, interest rate spreads on sovereign debt rise before the economy experiences a decline in productivity, suggesting that news about future economic developments may play an important role in these episodes. An empirical VAR estimation shows that a news shock has a larger contemporaneous impact on sovereign credit spreads than a comparable shock to labor productivity. A quantitative model of news and sovereign debt default with endogenous maturity choice generates impulse responses and a variance decomposition similar to the empirical VAR estimates. The dynamics of the economy after a bad news shock share some features of a productivity shock and some features of sudden stop events. However, unlike during sudden stop episodes, long-term debt does not shield the country from bad news shocks, and it may even exacerbate default risk. Finally, an increase in the precision of news allows the government to improve its debt maturity management, especially during periods of high stress in credit markets, and thus face lower yield spreads while increasing the amount of debt.
This work analyzes and quantifies how the mining sector affects the other macroeconomic variables in Chile, with special focus on understanding the macroeconomic factors that have helped Chile to avoid the Natural Resource Curse. To do this, we use three complementary strategies. First, we review the related literature and present aggregate statistical data for the mining sector in order to illustrate the significant impact of this sector on the key macroeconomic variables in Chile. Second, using semi-structural econometric evidence, we estimate the macroeconomic effects of changes in copper prices and mining production. Third, we develop a structural macroeconomic model that enables analysis of the macroeconomic effects of mining sector shocks. The results show that the development of the mining sector in Chile has been beneficial to the non-mining GDP, investment, fiscal revenue and labor market. Using the structural model, we also quantify the macroeconomic effects of mining development in Chile during 1996–2005. The structural model also provides a quantification of the role of the fiscal rule and production interlinkages in enhancing these macroeconomic effects. Finally, an extended version of the model, separating mining production into regional zones, confirms the previous results and underscores the difference in production interlinkages across mining regions.
We investigate the hypothesis that an RBC model driven by permanent and transitory productivity shocks can explain well observed business-cycle fluctuations in emerging countries. A drawback of existing studies is the use of short samples to identify permanent shifts in productivity. We overcome this difficulty by using more than one century of Argentine data to estimate the structural parameters of a small-open-economy RBC model. We place particular emphasis on the behavior of the trade balance because this variable plays a central role in all existing empirical or theoretical characterizations of the developing-country business-cycle. We find that the RBC model predicts a near random walk behavior for the trade balance-to-output ratio with a flat autocorrelation function close to unity. By contrast, in the data, the autocorrelation function of the trade balance-to-output ratio is significantly below unity and converges quickly to zero, resembling the one implied by a stationary autoregressive process. In addition, we show that the RBC model fails to capture a number of other important aspects of the emerging-market business cycle, including the volatilities of output, consumption, investment, and the trade balance.
Existing results on the contribution of terms of trade and world interest rate shocks to output fluctuations in small open economies range from less than 10% to almost 90%. We argue that an identification problems lies at the heart of these vastly di¤erent results. In this paper, we overcome this by estimating a DSGE model using a structural Bayesian estimation approach. We apply our methodology to five developed and developing economies.. Our approach allows us to e?ciently exploit cross-equation restrictions implied by the structural model. We find that world interest rate shocks are the main driving forces of business cycles in small open economies while terms of trade shocks are not.
We explore the hypothesis that fluctuations in commodity prices are an important driver of business cycles in small emerging market economies (EMEs). First, we document that commodity prices exhibit strong comovement with other macro variables along the business cycle of these economies; and that a common factor accounts for most of the time series dynamics of these commodity prices. Guided by these stylized facts, we embed a commodity sector into a dynamic, stochastic, multi-country business cycle model of EMEs where exogenous fluctuations in commodity prices coexist with other driving forces. Commodity prices follow a common dynamic factor structure in the model. When estimated with EMEs data, the model gives to commodity shocks, mostly in the form of perturbations to their common factor, a paramount role when accounting for aggregate dynamics: more than a third of the variance of real output across the EMEs considered is associated to commodity price shocks. The model also performs well when accounting for other business cycle facts. A further amplification mechanism is a “spillover” effect from commodity prices to interest rates. Yet, sometimes, positive commodity price shocks have also cushioned other negative domestic shocks, particularly during the fast recovery from the world financial crisis.
Business cycles are substantially correlated across countries. Yet, most existing models are not able to generate substantial transmission through international trade. We show that the nature of such transmission depends fundamentally on the features determining the responsiveness of labor supply and labor demand to international relative prices. We augment a standard international macroeconomic model to incorporate three key features: a weak short-run wealth effect on labor supply, variable capital utilization, and imported intermediate inputs for production. This model can generate large and significant endogenous transmission of technology shocks through international trade. We demonstrate this by estimating the model using data for Canada and the United States with limited-information Bayesian methods. We find that this model can account for the substantial transmission of permanent U.S. technology shocks to Canadian aggregate variables such as output and hours, documented in a structural vector autoregression. Transmission through international trade is found to explain the majority of the business cycle comovement between the United States and Canada.
Conventional wisdom states that the labor income share is stable and countercyclical. This paper claims that this conventional wisdom is not valid in emerging economies. Using annual labor income shares data of 40 years around the world, we find three empirical regularities. First, labor income shares are rarely stable and are as volatile as output. Second, labor income shares in emerging economies are twice as volatile as those in advanced economies. Third, on average, labor income shares in emerging economies are procyclical, whereas they are countercyclical in advanced economies.
The atemporal elasticity of substitution parameter plays an important role in the analysis of the macroeconomic equilibrium of a small open economy. There has been various research papers estimating this parameter in the literature. This note offers a survey of this literature.
This paper uses a panel structural vector autoregressive (VAR) model to investigate the extent to which global financial conditions, i.e., a global risk-free interest rate and global financial risk, and country spreads contribute to macroeconomic fluctuations in emerging countries. The main findings are: (1) global financial risk shocks explain about 20% of movements both in the country spread and in the aggregate activity in emerging economies. (2) The contribution of global risk-free interest rate shocks to macroeconomic fluctuations in emerging economies is negligible. Its role, which was emphasized in the literature, is taken up by global financial risk shocks. (3) Country spread shocks explain about 15 percent of the business cycles in emerging economies. (4) Interdependence between economic activity and the country spread is a key mechanism through which global financial shocks are transmitted to emerging economies.
,We thank our discussants Larry Christiano, Mick Devereux, Fabrizio Perri, C edric Tille, and V. V. Chari, Marty Eichenbaum, Peter Ireland, Paolo Pesenti, Morten Ravn, Sergio Rebelo, Stephanie Schmitt-Groh e, Alan Stockman, Mart n Uribe, along with seminar participants at the AEA meetings, the SED meetings, Boston College, the Canadian Macro Study Group, Duke University, the Ente Einaudi, the European Central Bank, the European University Institute, the Federal Reserve Bank of San Francisco, IGIER, the IMF, New York University, Northwestern University, the University of Pennsylvania, the University of Rochester, the University of Toulouse, the Wharton Macro Lunch group, and the workshop \Exchange rates, Prices and the International Transmission Mechanism" hosted by the Bank of Italy, for many helpful comments and criticism. Corsetti's work on this paper is part of a research network on \The Analysis of International Capital Markets: Understanding Europe's Role in the Global Economy," funded by the European Commission under the Research Training Network Programme (Contract No. HPRN-CT-1999-00067). Part of Dedola's work on this paper was carried out while he was visiting the Department of Economics of the University of Pennsylvania, whose hospitality is gratefully acknowledged. The views expressed here are those of the authors and do not necessarily re ect the positions of the ECB, the Board of Governors of the Federal Reserve System, or any other institution with which the authors are a liated.,Address: Via dei Roccettini 9, San Domenico di Fiesole 50016, Italy; email: Giancarlo. Corsetti@iue. it.,Address: Postfach 16 013 19, D-60066 Frankfurt am Main, Germany; email: luca. dedola@ecb. int.,Address: 20th and C Streets, N. W., Stop 23, Washington, DC 20551, USA; email: Sylvain. Leduc@. frb. gov.
This paper documents the empirical relation between the interest rates that emerging economies face in international capital markets and their business cycles. The dataset used in the study includes quarterly data for Argentina during 1983-2000 and for Brazil, Mexico, Korea, and Philippines,during 1994-2000. In this sample, interest rates are very volatile, strongly countercyclical, and strongly positively correlated with net exports. Output is very volatile and consumption is more volatile than output. These regularities are common to all emerging economies in the sample, butare not observed in a developed economy such as Canada. The paper presents a dynamic general equilibrium model of a small open economy, in which (i) firms have to pay for a fraction of the input bill before production takes place, and in which (ii) the labor supply is independent of consumption.Using a version of the model calibrated to Argentina s economy, we find that interest rate shocks alone can explain 50% of output fluctuations and can generate business cycle patterns consistent with the regularities described above and with the major booms and recessions in Argentina in the last two decades. We conclude that interest rates are an important factor for explaining businesscycles in emerging economies and further research should be devoted to fully understand their determination.
We show how changes in the volatility of the real interest rate at which small open emerging economies borrow have an important effect on variables like output, consumption, investment, and hours. We start by documenting the strong evidence of time-varying volatility in the real interest rates faced by four emerging economies: Argentina, Brazil, Ecuador, and Venezuela. We estimate a stochastic volatility process for real interest rates. Then, we feed this process in a standard small open economy business cycle model. We find that an increase in real interest rate volatility triggers a fall in output, consumption, investment, hours, and debt. (JEL E13, E20, E32, E43, F32, F43, 011)
Since Friedman [Essays in Positive Economics, University of Chicago Press, Chicago (1953) 157–203] an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973–96) of 75 developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedman’s hypothesis. The paper also examines the importance of terms-of-trade shocks in explaining the overall variance of output and prices in developing countries.
We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.
This paper assesses whether partial exchange-rate pass-through to trade prices has important implications for the prospective adjustment of global external imbalances. To address this question, we develop and estimate an open-economy DSGE model in which pass-through is incomplete due to the presence of local currency pricing, distribution services, and a variable demand elasticity that leads to fluctuations in optimal markups. We find that the overall magnitude of trade adjustment is similar in a low and high pass-through environment with more adjustment in a low pass-through world occurring through movements in the terms of trade rather than real trade flows and through a larger response of the exchange rate.
This paper demonstrates that an estimated, structural, small open-economy model of the Canadian economy cannot account for the substantial influence of foreign-sourced disturbances identified in numerous reduced-form studies. The benchmark model assumes uncorrelated shocks across countries and implies that U.S. shocks account for less than 3% of the variability observed in several Canadian series, at all forecast horizons. Accordingly, model-implied cross-correlation functions between Canada and U.S. are essentially zero. Both findings are at odds with the data. A specification that assumes correlated cross-country shocks partially resolves this discrepancy, but still falls well short of matching reduced-form evidence. One central difficulty resides in the model's inability to account for comovement without generating counter factual implications for the real exchange rate, the terms of trade and Canadian inflation.
The inability to replicate positive international comovement of investment spending and employment remains one of the most vexing issues facing the international real business cycle (IRBC) research program. To attack this so-called “comovement problem,” I develop a multisector IRBC model highlighting the role of non-traded goods and international capital mobility. In addition to broadly replicating prior IRBC successes, the model more importantly delivers positive international investment and employment correlations. The model is also able to generate internally the observed result that variables associated with traded goods sectors exhibit higher volatility than those in non-traded sectors.
The primary aim of the paper is to place current methodological discussions in macroeconometric modeling contrasting the ‘theory first’ versus the ‘data first’ perspectives in the context of a broader methodological framework with a view to constructively appraise them. In particular, the paper focuses on Colander’s argument in his paper “Economists, Incentives, Judgement, and the European CVAR Approach to Macroeconometrics” contrasting two different perspectives in Europe and the US that are currently dominating empirical macroeconometric modeling and delves deeper into their methodological/philosophical underpinnings. It is argued that the key to establishing a constructive dialogue between them is provided by a better understanding of the role of data in modern statistical inference, and how that relates to the centuries old issue of the realisticness of economic theories.
This paper shows that aggregate investment expenditure shares on tradable and nontradable goods are very similar in rich and poor countries, as well as in different regions of the world. Furthermore, the two expenditure shares have remained close to constant over time, with the average expenditure share on nontradables varying between 0.54-0.62 over the 1960-2004 period. The results of this paper offer a new restriction for two-sector models of the aggregate economy. Combined with the fact that the relative price of nontradables correlates positively with income and exhibits large differences across space and time, our findings suggest that tradable and nontradable goods in investment can be modeled using the Cobb-Douglas aggregator. (Copyright: Elsevier)
This paper examines the relationship between terms of trade and business cycles using a three-sector intertemporal equilibrium model and a large multicountry database. Results show that terms-of-trade shocks account for nearly one-half of actual GDP variability. The model explains weak correlations between net exports and terms of trade (the Harberger, Laursen, and Metzler effect), and produces large and weakly correlated deviations from purchasing power parity and real interest rate parity. Terms-of-trade shocks cause real appreciations and positive interest differentials, although productivity shocks have opposite effects. The puzzle that welfare gains of international asset trading are negligible is left unresolved. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
This paper shows that standard international business cycle models can be reconciled with the empirical evidence on the lack
of consumption risk sharing. First, we show analytically that with incomplete asset markets productivity disturbances can
have large uninsurable effects on wealth, depending on the value of the trade elasticity and shock persistence. Second, we
investigate these findings quantitatively in a model calibrated to the U.S. economy. With the low trade elasticity estimated
via a method of moments procedure, the consumption risk of productivity shocks is magnified by high terms of trade and real
exchange rate (RER) volatility. Strong wealth effects in response to shocks raise the demand for domestic goods above supply,
crowding out external demand and appreciating the terms of trade and the RER. Building upon the literature on incomplete markets,
we then show that similar results are obtained when productivity shocks are nearly permanent, provided the trade elasticity
is set equal to the high values consistent with micro-estimates. Under both approaches the model accounts for the low and
negative correlation between the RER and relative (domestic to foreign) consumption in the data—the “Backus-Smith puzzle”.
This paper analyzes a real-business-cycle model of a small open economy. The model is parameterized, calibrated, and simulated to explore its ability to rationalize the observed pattern of postwar Canadian business fluctuations. The results show that the model mimics many of the stylized facts using moderate adjustment costs and minimal variability and persistence in the technological disturbances. In particular, the model is consistent with the observed positive correlation between savings and investment, even though financial capital is perfectly mobile, and with countercyclical fluctuations in external trade. Copyright 1991 by American Economic Association.
This paper attempts to disentangle the intricate relation linking the world interest rate, country spreads, and emerging-market fundamentals. It does so by using a methodology that combines empirical and theoretical elements. The main findings are: (1) US interest rate shocks explain about 20% of movements in aggregate activity in emerging economies. (2) Country spread shocks explain about 12% of business cycles in emerging economies. (3) In response to an increase in US interest rates, country spreads first fall and then display a large, delayed overshooting; (4) US-interest-rate shocks affect domestic variables mostly through their effects on country spreads; (5) The feedback from emerging-market fundamentals to country spreads significantly exacerbates business-cycle fluctuations.
The small open economy model with incomplete asset markets features a steady state that depends on initial conditions. In addition, equilibrium dynamics posses a random walk component. A number of modifications to the standard model have been proposed to induce stationarity. This Paper presents a quantitative comparison of these alternative approaches. Five different specifications are considered: (1) A model with an endogenous discount factor (Uzawa-type preferences); (2) A model with a debt-elastic interest-rate premium; (3) A model with convex portfolio adjustment costs; (4) A model with complete asset markets; (5) A model without stationarity-inducing features. The main finding of the Paper is that all models deliver virtually identical dynamics at business-cycle frequencies, as measured by unconditional second moments and impulse response functions. The only noticeable difference among the alternative specifications is that the complete-asset-market model induces smoother consumption dynamics.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
This paper studies the initial effects of exchange-rate-based stabilization programs within a dynamic general equilibrium model of a small open economy in which inflation acts as a tax on intermediate transactions and capital accumulation is subject to convex adjustment costs and gestation lags. The model replicates the typical pattern of slow inflation convergence, sustained real exchange rate appreciation, trade balance deterioration, and expansion in domestic spending followed by a deflationary slowdown, without resorting to sticky prices, imperfect credibility, or adaptive expectations. Calibrated versions of the model are compared with the initial effects of the Argentine Convertibility Plan of April 1991.
The report argues that aid volatility is an important source of volatility for the poorest countries. Following a method already applied by the Agence Française de Développement, the report argues that loans to LICs should incorporate a floating grace period, which the country could draw upon when hit by a shock. The definition of a shock should include aid uncertainty, along with others such as commodity shocks and natural disasters. The idea is calibrated to a key IMF policy instrument towards Low-Income Countries, the Poverty-Reducing and Growth Facility (PRGF).
Le rapport montre que l’aide aux pays pauvres contribue à accroître la volatilité de ces pays. Suivant une méthode déjà élaborée par l’Agence Française de Développement, l’article propose d’accorder des crédits aux pays pauvres, qui incorporent un droit de grâce flexible, utilisable par le pays, lorsqu’il est confronté à un choc négatif, quelle qu’en soit la cause : choc d’aide, de prix des matières premières ou catastrophe naturelle. Il montre comment l’instrument utilisé par le FMI à destination des pays pauvres, le PRGF, pourrait être modifié pour ce faire.
Matlab codes for 'Closing Small Open Economy Models.' Notes: (1) Symbolic Math Toolbox is required (2) The files listed under "General Tools" below are required. Contents: Endogenous Discount Factor Model: mendoza91.m, mendoza91_ss.m, mendoza91_run.m; Endogenous Discount Factor Model without Internalization: mendoza91s.m, mendoza91s_ss.m, mendoza91s_run.m; Debt Elastic Interest Rate Model: deir.m, deir_ss.m, deir_run.m; Portfolio Adjustment Cost Model: bac.m, bac_ss.m, bac_run.m; Complete Asset Markets Model: cam.m, cam_ss.m, cam_run.m; The Nonstationary Case: rw.m, rw_ss.m, rw_run.m; General Tools: gx_hx.m, solab.m (by Paul Klein), qzswitch.m (by Chris Sims), reorder.m (taken from Paul Klein's website), anal_deriv.m, num_eval.m, mom.m, ir.m.
Business Cycles in Emerging Markets and Implications for the Real Exchange Rate
- E Aguirre
AGUIRRE, E., "Business Cycles in Emerging Markets and Implications for the Real Exchange Rate," Ph.D.
Dissertation, Columbia University, 2011.
Macroeconomic Effects of Commodity Booms and Busts
- S Shousha
SHOUSHA, S., "Macroeconomic Effects of Commodity Booms and Busts," mimeo, Columbia University,
2015.