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Business Cycle Persistence in Developing Countries: How Successful is a DSGE Model with a Vertical Production Chain and Sticky Prices?

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  • Rachel Male

    () (Queen Mary, University of London)

Abstract

It is well documented that business cycles of developed countries are characterised by persistent output fluctuations, and this has been the subject of much theoretical interest. However, the case for developing countries has been somewhat neglected in the literature. This paper addresses this imbalance, revealing that whilst both developed and developing countries exhibit persistent output fluctuations, there is a significant positive relationship between output persistence and level of economic development. This relationship was successfully modelled using a vertical production chain DSGE model (Huang and Liu, 2001). This model lends itself to such an analysis, as by altering the number of production stages (N) it is possible to represent economies at different levels of development. However, calibration of low input-output (γ) parameter values for the US and UK effectively inhibited the model from generating enough persistence to match that observed in these countries. Nonetheless, after abstracting from the US and UK results, there was found to be a strong significant positive relationship between the magnitude of output persistence generated by the model and economic development. A final very significant finding of this analysis is that the model overestimates output persistence in high inflation countries and underestimates output persistence in low inflation countries. This has important implications not only for this model, but also for any economist attempting to construct a business cycle model capable of replicating the observed patterns of output persistence.

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Paper provided by Queen Mary, University of London, School of Economics and Finance in its series Working Papers with number 672.

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Date of creation: Oct 2010
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Handle: RePEc:qmw:qmwecw:wp672

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Keywords: Output persistence; Vertical production chain; Staggered price contracts; Economic development; Inflation;

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  1. Basu, Susanto, 1995. "Intermediate Goods and Business Cycles: Implications for Productivity and Welfare," American Economic Review, American Economic Association, vol. 85(3), pages 512-31, June.
  2. Etienne Gagnon, 2009. "Price Setting During Low and High Inflation: Evidence from Mexico," The Quarterly Journal of Economics, MIT Press, vol. 124(3), pages 1221-1263, August.
  3. Seong, Byeongchan & Mahbub Morshed, A.K.M. & Ahn, Sung K., 2006. "Additional sources of bias in half-life estimation," Computational Statistics & Data Analysis, Elsevier, vol. 51(3), pages 2056-2064, December.
  4. Kiley, Michael T, 2000. "Endogenous Price Stickiness and Business Cycle Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(1), pages 28-53, February.
  5. Choi, Chi-Young & Mark, Nelson C. & Sul, Donggyu, 2006. "Unbiased Estimation of the Half-Life to PPP Convergence in Panel Data," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(4), pages 921-938, June.
  6. Masao Ogaki & Vikas Kakkar, 2002. "The Distortionary Effects of Inflation: An Empirical Investigation," Working Papers 02-01, Ohio State University, Department of Economics.
  7. Zachariadis, Theodoros, 2007. "Exploring the relationship between energy use and economic growth with bivariate models: New evidence from G-7 countries," Energy Economics, Elsevier, vol. 29(6), pages 1233-1253, November.
  8. Rachel Male, 2010. "Developing Country Business Cycles: Revisiting the Stylised Facts," Working Papers 664, Queen Mary, University of London, School of Economics and Finance.
  9. Brandt, Nicola, 2007. "Mark-ups, economies of scale and the role of knowledge spillovers in OECD industries," European Economic Review, Elsevier, vol. 51(7), pages 1708-1732, October.
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