Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies

Rudrani Bhattacharya and Ila Patnaik

No 2013/120, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: WP; business cycle; closed economy; Macroeconomics; real business cycles; emerging market business cycle stylized facts; financial development; consumption volatility; labour productivity; aggregate consumption; consumption cycle; volatility rise; volatility of consumption; Consumption; Financial sector development; Income; Income shocks; Africa; Eastern Europe; East Asia; South Asia; Asia and Pacific (search for similar items in EconPapers)
Pages: 33
Date: 2013-05-22
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Citations: View citations in EconPapers (7)

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