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Interest rates and business cycles in emerging economies: The role of financial frictions

  • Fernández, Andrés


    (Research Department, Inter-American Development Bank)

  • Gulan, Adam


    (Bank of Finland Research)

Countercyclical country interest rates have been shown to be both a distinctive characteristic and an important driving force of business cycles in emerging market economies. In order to account for this, most business cycle models of emerging market economies have relied on ad hoc and exogenous countercyclical interest rate processes. We embed a financial contract à la Bernanke et al. (1999) into a standard small open economy business cycle model that endogenously delivers countercyclical interest rates. We then take the model to the data. For this purpose we build a novel panel dataset for emerging economies that includes financial data, namely sovereign and corporate interest rates as well as leverage. We show that the model accounts well not only for countercyclical interest rates, but also for other stylized facts of emerging economies' business cycles, including the dynamics of leverage.

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Paper provided by Bank of Finland in its series Research Discussion Papers with number 23/2012.

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Length: 48 pages
Date of creation: 18 Jun 2012
Date of revision:
Publication status: Published as Fernández, Andrés and Adam Gulan, 'Interest rates and business cycles in emerging economies: The role of financial frictions' in American Economic Journal: Macroeconomics, 2015, pages 153-188.
Handle: RePEc:hhs:bofrdp:2012_023
Contact details of provider: Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
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