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The Role of Interest Rates and Productivity Shocks in Emerging Market Fluctuations

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  • Mark Aguiar
  • Guita Gopinath

Abstract

In this paper we use a quantitative model to explore the potential frictions that distinguish emerging market business cycles from developed small open economies. Following Aguiar and Gopinath (2007) we allow total factor productivity (TFP) to have a stationary and an integrated component. We also allow for shocks to the consumption and investment Euler Equations that operate through the interest rate. These “wedges” represent changes in the intertemporal marginal rate of transformation, which may be due to changes in observed interest rates, unobserved borrowing constraints, or other financial frictions. We estimate the model using data from Mexico and Canada. We show that interest rate shocks orthogonal to domestic TFP fail to explain the behavior of emerging markets. We then allow for interest rates to respond to/co-vary with productivity shocks. We find that emerging market business cycles appear to be driven by large shocks to trend income combined with relatively small transitory shocks tha co-vary with the interest rate.

Suggested Citation

  • Mark Aguiar & Guita Gopinath, 2007. "The Role of Interest Rates and Productivity Shocks in Emerging Market Fluctuations," Working Papers Central Bank of Chile 445, Central Bank of Chile.
  • Handle: RePEc:chb:bcchwp:445
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    References listed on IDEAS

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    1. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
    2. James A. Schmitz, Jr. & Arilton Teixeira, 2008. "Privatization's Impact on Private Productivity: The Case of Brazilian Iron Ore," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 745-760, October.
    3. Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
    4. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    5. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
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    Cited by:

    1. Chen, Sheng-Syan & Chen, Hsien-Yi & Chang, Chong-Chuo & Yang, Shu-Ling, 2016. "The relation between sovereign credit rating revisions and economic growth," Journal of Banking & Finance, Elsevier, vol. 64(C), pages 90-100.
    2. Anand, Rahul & Prasad, Eswar, 2010. "Optimal Price Indices for Targeting Inflation under Incomplete Markets," IZA Discussion Papers 5137, Institute for the Study of Labor (IZA).
    3. Chang, Yanqin & Smith, R. Todd, 2014. "Feldstein–Horioka puzzles," European Economic Review, Elsevier, vol. 72(C), pages 98-112.
    4. Скрыпник Д.В., 2016. "Макроэкономическая Модель Российской Экономики," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 52(3), pages 92-113, июль.

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