Macroeconomic Fluctuations in Emerging Economies: An Unobserved Components Approach

We employ a multivariate correlated unobserved components model to investigate the interaction between the permanent and transitory movements in output for two groups of emerging economies: one group in Asia and the other in Latin America. Our empirical framework enables us to assess the relative importance of permanent versus transitory shocks in driving output growth rate correlations across countries, providing an alternative to dynamic factor models for analyzing international co-movements. Our results suggest that GDP in all the emerging economies have highly variable stochastic permanent components with innovations that are negatively correlated with their respective transitory movements. We also find that the Asian countries in our sample share a significant fraction of innovations to output whereas output disturbances are largely idiosyncratic for the Latin American countries. These results lead us to conclude that Asia may be a plausible candidate for a monetary union, whereas Latin American countries do not seem similar enough in terms of macroeconomic fluctuations to gain from sharing a common currency.