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Productivity or Demand? Identifying Sources of Fluctuations in Small Open Economies

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  • Jacek Rothert

    (University of Texas, Austin)

Abstract

Business cycles in emerging markets are different than in developed economies: consumption fluctuates more than output and trade balance is strongly counter-cyclical. The two leading theories to account for those differences are: (i) permanent productivity shocks and (ii) interest rate shocks. I show movements in terms of trade can distinguish between these two theories. Expansionary productivity shocks reduce the relative price of country's exports. Expansionary interest rate shocks raise the relative price of country's exports. Application of this method to Mexican fluctuations in the 1990s yields results consistent with leading methods based on Bayesian inference. The difference is that in this paper identification relies on instantaneous response of price rather than long-run properties of quantities. Identification can be based on relatively short time series and the method can be applied to real-time events. The method is best suited for cases when manufacturing constitutes large portion of both exports and imports.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 187.

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Date of creation: 2012
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Handle: RePEc:red:sed012:187

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  1. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
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  19. Oviedo, P. Marcelo, 2005. "World Interest Rate, Business Cycles, and Financial Intermediation in Small Open Economies," Staff General Research Papers 12360, Iowa State University, Department of Economics.
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