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Liquidity Contraints and Business Cycles in Developing Economies

  • Benoît Carmichael

    (Département d'Économique, Université Laval)

  • Sikoro Keita

    (USAID/Mali Results Center)

  • Lucie Samson

    (Département d'Économique, Université Laval)

Registered author(s):

    Open economy extensions of real business cycle models, even if generally successful, have met some difficulties replicating a few important stylized facts. In particular these models tend to predict excessive consumption smoothing and consumption correlation across countries. The observed negative correlation between the trade balance and output in developing countries, the variability of the trade balance and its correlation with the terms of trade have also proven difficult to reproduce. The paper considers how introduction of incomplete markets in the form of liquidity constraints can alleviate these problems. This analysis suggests that adding liquidity constraints helps predict the variability of consumption relative to output. It also improves our estimate of the correlation between the trade balance and output. The model correctly replicates the small positive correlation between the terms of trade and the trade balance. However, it slightly underpredicts the variability of the trade balance when fifty percent of the consumers are assumed to be liquidity constrained. (Copyright: Elsevier)

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    File URL: http://dx.doi.org/10.1006/redy.1998.0054
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    Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

    Volume (Year): 2 (1999)
    Issue (Month): 2 (April)
    Pages: 370-402

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    Handle: RePEc:red:issued:v:2:y:1999:i:2:p:370-402
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    1. Reinhart, Carmen & Ostry, Jonathan, 1992. "Saving and Terms of Trade Shocks: Evidence from Developing Countries," MPRA Paper 6976, University Library of Munich, Germany.
    2. Jean-Pierre Danthine & John B. Donaldson & Rajnish Mehra, 1992. "The equity premium and the allocation of income risk," Discussion Paper / Institute for Empirical Macroeconomics 60, Federal Reserve Bank of Minneapolis.
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    5. Enrique G. Mendoza, 1992. "The Effects of Macroeconomic Shocks in a Basic Equilibrium Framework," IMF Staff Papers, Palgrave Macmillan, vol. 39(4), pages 855-889, December.
    6. Michael A. Kouparitsas, 1996. "North-South financial integration and business cycles," Working Paper Series, Macroeconomic Issues WP-96-10, Federal Reserve Bank of Chicago.
    7. Reinhart, Carmen & Ostry, Jonathan, 1991. "Private Saving and Terms of Trade Shocks," MPRA Paper 13716, University Library of Munich, Germany.
    8. A. Senhadji Semlali, 1997. "Sources of Debt Accumulation in a Small Open Economy," IMF Working Papers 97/146, International Monetary Fund.
    9. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
    10. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
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