On the sources of aggregate fluctuations in emerging economies. Working Paper No. 15938, National Bureau of Economic Research

Recent research on macroeconomic fluctuations in emerging economies has resulted in two leading approaches: introducing a stochastic productivity trend, in addition to the temporary productivity shocks; or allowing for foreign interest rate shocks coupled with financial frictions. This paper compares the two approaches empirically, taking advantage of recent developments in the theory and implementation of Bayesian meth-ods. Our model comparison exercises favor models with financial frictions over the stochastic trend model. Our results are inconclusive in terms of which of the financial frictions we consider, working capital versus endogenous spreads, is a superior choice. Finally, a model that allows for both stochastic trends and financial frictions assign a substantial role to interest rate shocks, but not to trend shocks, in generating aggregate fluctuations. ∗We are immensely indebted to John Landon Lane for teaching us on Bayesian tools, and for providing us with the appropriate code. We also received very useful comments from Bora Durdu, Dave DeJong, Martin Uribe, and seminar participants at Rutgers, the Federal Reserve Board, the IMF, Universidad di Tella, and the University of Pittsburgh. Of course, any errors or shortcomings are ours