How Do Emerging Markets Respond to Macroeconomic Shocks? - Dynamic Panel Evidence on the Effects of Disasters

Business cycles in emerging markets are characterized by several features that seem difficult to reconcile with consumption smoothing, such as volatile consumption and strongly countercyclical current accounts. Although there are several alternative approaches trying to explain business cycles in emerging markets by modeling different shocks and transmission mechanisms, there is little direct evidence about exogenous shocks and their transmission in emerging markets. Using a newly constructed dataset on disaster events, I test how emerging markets respond to actual exogenous shocks in a dynamic panel distributed lag model. This approach allows me to identify the dynamic effects of shocks on macroeconomic variables while controlling for unobserved global shocks, unobserved time invariant characteristics of different countries and the possible serial correlations in macroeconomic aggregates. My results show that political shocks and terrorist attacks can drive business cycles in emerging markets, having a significant and long-lasting negative effect on output and the domestic components of aggregate absorption. I also test whether savings, investments and the current account respond to these shocks as suggested by forward-looking models.