On the Sources of Aggregate Fluctuations in Emerging Economies

Abstract

Recent research on macroeconomic fluctuations in emerging economies has focused in two leading approaches: introducing a stochastic productivity trend, in addition to temporary productivity shocks; or allowing for foreign interest rate shocks coupled with financial frictions.This paper compares the two approaches empirically, and also evaluates a model that encompasses them, taking advantage of recent developments in the theory and implementation of Bayesian methods.The encompassing model assigns a significant role to interest rate shocks and financial frictions, but not to trend shocks, in generating and amplifying aggregate fluctuations.Formal model comparison exercises favor models with financial frictions over the stochastic trend model, although this is sensitive to the inclusion of measurement errors.Of the two financial frictions we consider, working capital versus spreads linked to expected future productivity, the latter emerges as key for a reasonable approximation to the data.

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