Markups and the real effects of volatility shocks

This article studies the role of endogenous markups in the transmission of volatility shocks in real models. I design a variant of a small open economy model with volatility shocks and firm dynamics that gives rise to endogenous markups. I calibrate this model to match the business cycle facts in emerging economies and show that the impact of volatility shocks is substantially amplified if markups are endogenously time varying. Volatility shocks increase savings, due to precautionary motives, and markups, which act as a wedge that endogenously decreases real wages and labor supply with further negative aggregate dynamics that are absent in the models with constant markupsSupport from Fundaci ´ on Ram´ on Areces and the Ministerio Econom´ıa y Competitividad (Spain), grants 2014- ECO2014-56676-C2-1-P,MDM2014-0431, and Comunidad de Madrid, MadEco-CM (S2015/HUM-3444) are gratefully acknowledged