Accounting for business cycle regularities in emerging economies

Thesis (Ph. D.)--University of Rochester. Dept. of Economics, 2013.Chapter 1 documents empirical regularities of emerging economies over the business cycle. Business cycle regularities in emerging economies display distinct features when compared to developed economies. While labor is consistently less volatile, the labor wedge is prevalent and volatile as in developed economies. Furthermore, the interest rates households face are quite different from the ones firms face. Data shows that households face rates which are less volatile. I argue that these empirical observations are difficult to reconcile with the previously explored frameworks in the literature. Chapter 2 develops an economic model to account for business cycle regularities in emerging economies. The model involves three modifications to an otherwise standard small open economy real business cycle model. Preferences are Cobb-Douglas, firms are subject to a working capital friction, and, more importantly, firms and households face differentiated interest rate shocks. The novel feature is the presence of a wedge between the two different interest rates. While the interest rate for firms shifts labor demand via the working capital channel, the rate for households induces countering labor supply responses via Cobb-Douglas preferences. Accordingly, the overall labor response depends on the size of the wedge between the two interest rates. The model replicates the level of labor volatility observed in emerging economies. Model calibration demonstrates that the differentiated interest rates play a critical role in delivering these results. Chapter 3 documents the positive comovement of saving and investment for emerging economies over the business cycle. The model developed in Chapter 2 delivers this correlation while accounting for other key moments. With Cobb-Douglas preferences, the dampened volatility of interest rates for households allows the TFP shock to play a larger role on their saving behavior. Coincidentally, the change in the response of labor from interest rate shocks that households face, extensively argued in Chapter 2, is key in generating this result. Consequently, by devising the TFP shock to be a sizable driving force behind both saving and investment, the model delivers a positive correlation between the two variables