Why is consumption more volatile than output in emerging markets?

Standard real business cycle theory predicts that consumption should be smoother than output, as observed in developed coun- tries. In this paper we provide a novel explanation of the consumption volatility puzzle based on political factors. In our model groups that disagree on the size of government alternate in power and face aggre- gate uncertainty. While productivity shocks only affect consumption through responses to output, political shocks change the composi- tion between private and public consumption for a given output size. As less stable governments and more polarized societies characterize emerging market economies the effects of political shocks are more pro- nounced. For a reasonable set of parameters we confirm the empirical relationship between political polarization and the ratio of consump- tion volatility to output volatility across countries.