Emerging Market Business Cycles: The Cycle Is the Trend

TLDR

Emerging market business cycles are marked by strongly countercyclical current accounts, consumption volatility that exceeds income volatility, sudden stops in capital inflows, and differ from developed small open economies, suggesting substantial volatility in trend growth. Our methodology exploits consumption and net export data to identify the persistence of productivity. We find that a standard equilibrium model explains both emerging and developed markets, with shocks to trend growth—not transitory fluctuations—being the primary source of emerging market business cycle fluctuations, thereby accounting for their key features.

Abstract

Emerging market business cycles exhibit strongly countercyclical current accounts, consumption volatility that exceeds income volatility, and "sudden stops" in capital inflows. These features contrast with developed small open economies. Nevertheless, we show that a standard model characterizes both types of markets. Motivated by the frequent policy regime switches observed in emerging markets, our premise is that these economies are subject to substantial volatility in trend growth. Our methodology exploits the information in consumption and net exports to identify the persistence of productivity. We find that shocks to trend growth—rather than transitory fluctuations around a stable trend—are the primary source of fluctuations in emerging markets. The key features of emerging market business cycles are then shown to be consistent with this underlying income process in an otherwise standard equilibrium model.