The Transmission of US Shocks to Emerging Markets∗

To study the transmission of US shocks to emerging markets, we develop and estimate an asymmetric two-country real business cycle model. The asymmetries in the model arise due to the differences in the size and the riskiness of the economies, as well as the financial frictions in the emerging market. We estimate the model using 17 quarterly time series for Mexico and the US from 1994.I to 2007.IV. We find that US shocks explain 31 % of the volatility in Mexico’s GDP growth, which is the second largest source of GDP growth fluctuations, only after domestic productivity shocks, which explain 43%. A historical decomposition of the data shows that Mexico’s growth substantially benefited from the US growth in the second part of the 1990s, contributing an additional annual growth of one percentage point on average. On the other hand, the 2001 US recession hit Mexico’s economy adversely, resulting in growth losses of 3 percentage points in that year. The transmission mechanisms built in the model imply that the spillovers are more sensitive to the financial frictions than to the volume of bilateral trade. Key Words: Emerging market business cycles; transmission of foreign shocks; estimated two-country mode