Medium Term Business Cycles in Developing Countries
Executive Summary — Business cycle fluctuations in developed economies tend to have very strong effects on developing countries, says a new study by Harvard Business School professor Diego Comin, Norman Loayza and Luis Serven of the World Bank, and Farooq Pasha of Boston College. The researchers have developed a quantitative model capable of explaining the amplitude and persistence of the effect that U.S. shocks have on Mexico's macroeconomic variables. The model is then used to provide an account of the drivers of business fluctuations in developing economies. Key concepts include:
- U.S. shocks have a larger effect on Mexico than on the U.S. in terms of GDP.
- The slow diffusion of technologies to Mexico generates a hump-shaped response in Mexican output to U.S. shocks.
- Mexico's consumption is more volatile than its output.
- The model can be a useful starting point for obtaining a better understanding of business cycle fluctuations in developing countries in general, and may be helpful for researchers wishing to introduce other relevant linkages, such as remittances or international capital flows other than FDI.
We build a two-country asymmetric DSGE model with two features: (1) endogenous and slow diffusion of technologies from the developed to the developing country and (2) adjustment costs to investment flows. We calibrate the model to match Mexico-U.S. trade and FDI flows. The model is able to explain the following stylized facts: (1) U.S. and Mexican output co-move more than consumption, (2) U.S. shocks have a larger effect on Mexico than in the U.S., (3) U.S. business cycles lead over medium-term fluctuations in Mexico, and (4) Mexican consumption is more volatile than output.