Download This PaperComparing Financial Frictions Models of the Business Cycle in Emerging Countries
42 Pages Posted: 19 Sep 2022 Last revised: 14 Apr 2024
Date Written: September 3, 2022
Abstract
This study evaluates the implications of various financial-friction models on business cycles in emerging economies. Employing a Bayesian approach, we not only assess models estimated linearly but also explore the nonlinear dynamics of these models estimated at second- and third-order approximations. The findings reveal that incorporating portfolio adjustment costs (PAC) significantly enhances the model's ability to replicate the observed stylized facts of emerging markets, outperforming models that rely solely on a debt-elastic interest rate (DEIR) mechanism. In particular, the model with PAC consistently shows that the main driving force is transitory productivity shocks regardless of the order of approximations. Moreover, the analysis underscores the necessity of second- and third-order approximations to accurately represent the asymmetric behavior of the trade balance across boom-and-bust cycles.
Keywords: Emerging economy, Financial frictions, Small open economy model, Nonlinearity
JEL Classification: E32, F43
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