Fiscal Policy in an Emerging Market Business Cycle Model

Abstract

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.

How quantitatively important is public investment for both business cycle fluctuations and output growth in Bulgaria (1999–2018)?

“…This differs from other emerging economies where consumption varies more than output, e.g Ghate (2016)…”

Fiscal austerity in emerging market economies

“…The economy consists of …rms, a government, and households. Firm wage payments are subject to working capital constraints, as in Neumeyer and Perri (2005) and Ghate, Gopalakrishnan, and Tarafdar (2016). Working capital constraints are the key …nancial friction in the model.…”

“…Our model builds on the work of Neumeyer and Perri (2005), Ghate, Gopalakrishnan, and Tarafdar (2016), and Hansen and Imrohoroglu (2016). We calibrate the model to India, which we view as a proto-typical small open economy, to understand the e¤ects of …scal contractions in small open emerging market economies.…”

“…In an emerging markets context, an example of G t can be public health or public transportation services whose quality is typically seen as being superior to private alternatives. SeeBarro (1981),Christiano and Eichenbaum (1992), andGhate et al (2016).…”

“…We assume R t to be an exogenous process. Typically in the literature, the international interest rate R t is assumed to be the US 91 day T-Bill rates (seeNeumeyer and Perri (2005),Ghate et al (2016)). …”