A Simple Model to Teach Business Cycle Macroeconomics for Emerging Market and Developing Economies

Abstract

The canonical neoclassical model is insufficient to understand business cycle fluctuations in emerging market and developing economies. The author reformulates the model proposed by Aguiar and Gopinath (2007) in a simple setting that can be used to teach business cycle macroeconomics for emerging market and developing economies at the undergraduate level. The simplified model is employed for qualitatively explaining facts such as the highly countercyclicality of the trade balance and the higher volatility of output and consumption compared with those observed in advanced countries.

Keywords:

• business cycles
• economic education
• emerging market economies
• undergraduate macroeconomics

JEL codes:

• A22
• E32
• F32

ACKNOWLEDGEMENTS

The author is grateful to Alfredo Baldini, Rose Rossiter, Patricia Toledo, and seminar participants at Ohio University and the Conference on Teaching and Research in Economic Education for useful suggestions and comments. He is also thankful for research assistance provided by Adanu Fafali, Soo Hyun Hwang, Sovanara (Johnny) Im, Lingqiao Tang, Md Shah Jalal Uddin, and Levi Weible.

Notes

¹For example, according to Ahumada and Butler (2009) and Lora and Ñopo (2009), the textbooks mostly used in Latin American countries are Sachs and Larraín (2002), Barro (1997), and Mankiw (2007), among others. For a more specialized textbook, see Montiel (2011). None of these includes a microfounded business cycle model for EMDEs. Barro (1997) has a closed-economy RBC model that is more suitable for understanding short-run fluctuations in a large, advanced economy. Textbooks authored or coauthored by Chilean economists such as De Gregorio (2012) and Sachs and Larraín (2002) do not contain a business cycle model for EMDEs.

²Pallage and Robe (2003) found that the welfare cost of consumption volatility in EMDEs is at least ten times that in the United States. Calderón and Fuentes (2014) concluded that recessions are deeper, steeper, and costlier among emerging market economies.

³The model proposed by Neumeyer and Perri (2005) is another important contribution in this literature. For a simplified version of the Neumeyer-Perri model, the reader is invited to see the author's Web page.

⁴A brief description of Aguiar and Gopinath's model is provided in the appendix.

⁵Curtis and Mark (2010) reported similar empirical findings for the Chinese business cycle during the 1978–2007 period. Although the literature has placed more emphasis on emerging markets, Uribe and Schmitt-Grohé (2014) presented evidence confirming that low-income, developing countries exhibit most of these characteristics as well.

⁶The online appendix is found at http://www.ohio.edu/people/duncanr1/file/OnlineAppendix.pdf.

⁷Many developing and emerging economies are net oil importers. A rise in the relative price of oil, an omitted input from a standard production function, can be modeled as a decline in total factor productivity (see Williamson 2013, ch. 12). Angelopoulos, Economides, and Vassilatos (2011) addressed the role of institutional quality as a source of fluctuations in productivity to explain GDP fluctuations in Mexico.

⁸Although it can be seen that current output is equally volatile, future output (Y′) is going to be less volatile because of the smaller changes in future TFP compared with the ones in EMDEs.