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Emerging Economy Business Cycles: Interest Rate Shocks vs Trend Shocks

Marc-Andre Letendre and Sabreena Obaid

Department of Economics Working Papers from McMaster University

Abstract: The recent literature studying the source of business cycles in emerging market economies (EMEs) has debated the relative importance of productivity trend shocks versus interest rate shocks coupled with financial frictions. Importantly, the papers where an important role was assigned to interest rate shocks did not force their models to match the historical paths of the world or country interest rate. This could have led to poorly identified interest rate shocks and inaccurate measures of contributions of shocks to EME business cycles. To address this issue, we estimate a small open economy model for Argentina and Mexico using Bayesian methods where world and country interest rate series are included as observables. This estimation strategy brings quantitative accuracy by imposing discipline on the estimated shocks. Although we find evidence in favour of both shocks, including interest rates as observables, shifts explanatory power away from trend shocks towards interest rate shocks.

Keywords: Business Fluctuations; Cycles; Financial Markets and the Macroeconomy (search for similar items in EconPapers)
JEL-codes: E44 F44 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2019-07
New Economics Papers: this item is included in nep-dge and nep-mac
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Handle: RePEc:mcm:deptwp:2019-07