Emerging market economy business cycles are typically characterized by high consumption and output volatility, strongly counter-cyclical current accounts, and countercyclical real interest rates. Evidence from the wider EME and less developed economy business cycle experience suggests however that real interest rates can also be procyclical. We reconcile the pro-cyclicality of real interest rates with the above facts by embedding …scal policy into a standard emerging market business cycle model. We show that …scal policy makes real interest rates a-cyclical or pro-cyclical. We use the model to replicate qualitatively some of the key features of the Indian business cycle.
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What are the quantitative effects of a government infused bank recapitalization in response to loan defaults? We analyze two different scenarios of government infused recapitalization using a dynamic stochastic general equilibrium (DSGE) model, calibrated to an emerging market economy with state owned banks. The first is an unconditional transfer and the second is an "equity in exchange for transfer" to banks. We show that a government infused recapitalization in response to a negative productivity shock may increase output in the short run. However, there is welfare loss, which is higher in the case of unconditional transfers. Our analysis suggests that bank recapitalization facilitates credit creation, capital formation and growth, especially during a cyclical downturn. There is however a need for appropriate policy vigil to protect the quality of public expenditure in the social sector that matters for welfare in the long run.
We investigate the sectoral and the distributional effects of a food subsidy program, where food consumption in the economy is subsidized by taxing the manufacturing good producers. In a two-agent model comprising of farmer and industrialist households, agents consume food to accumulate health. Simulations indicate that while the subsidy program increases food output and agents’ health both in the short run and the long run, manufacturing output and aggregate real GDP appear to fall in the short run and increase only in the long run. The program does not make both agents better off and exhibits social welfare gains for a limited range of subsidies.
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