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Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies

  • Rudrani Bhattacharya
  • Ila Patnaik

How does access to credit impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. We address this puzzle in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are credit constrained. Unconstrained households can respond to shocks to trend growth by raising current consumption more than rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre and post financial reform in India provides support for the model's key predictions.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 13/120.

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Length: 33
Date of creation: 22 May 2013
Date of revision:
Handle: RePEc:imf:imfwpa:13/120
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  1. Claudia M. Buch & Jörg Döpke & Christian Pierdzioch, 2002. "Financial Openness and Business Cycle Volatility," Kiel Working Papers 1121, Kiel Institute for the World Economy.
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