This paper documents the empirical relation between the interest rates that emerging economies face in international capital markets and their business cycles The dataset used in the study includes quarterly data for Argentina during 1983-2000 and for Brazil, Mexico, Korea, and Philippines,during 1994-2000 In this sample, interest rates are very volatile, strongly countercyclical, and strongly positively correlated with net exports Output is very volatile and consumption is more volatile than output These regularities are common to all emerging economies in the sample, butare not observed in a developed economy such as Canada The paper presents a dynamic general equilibrium model of a small open economy, in which (i) firms have to pay for a fraction of the input bill before production takes place, and in which (ii) the labor supply is independent of consumptionUsing a version of the model calibrated to Argentina s economy, we find that interest rate shocks alone can explain 50% of output fluctuations and can generate business cycle patterns consistent with the regularities described above and with the major booms and recessions in Argentina in the last two decades We conclude that interest rates are an important factor for explaining businesscycles in emerging economies and further research should be devoted to fully understand their determination

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID575501_code377850.pdf?abstractid=575501&mirid=1

Business Cycles in Emerging Economies:The Role of Interest Rates

http://www.fperri.net/papers/neuperri.pdf

Business Cycles in Emerging Economies: The Role of Interest Rates

Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.

Default risk and income fluctuations in emerging economies

The evidence from Sudden Stops in emerging economies shows that financial crashes are generally followed by major economic crises. This paper explains this phenomenon as an equilibrium outcome of a business cycle model with an endogenous collateral constraint that induces amplification and asymmetry in the responses of macro-aggregates to shocks. Cyclical dynamics produce economic expansions during which the ratio of debt to asset values raises enough to hit the constraint, triggering a Fisherian deflation that causes a spiraling decline in credit and in the price and quantity of collateral assets. Output and factor allocations also fall because the collateral constraint cuts access to working capital financing. In the long run, precautionary saving makes Sudden Stops low probability events nested within normal cycles, as observed in the data.

/pdf/sudden-stops-financial-crises-and-leverage-10odewfbhh.pdf

Sudden Stops, Financial Crises, and Leverage

Recent sovereign defaults in emerging countries are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output, consumption, and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default occurs in equilibrium because asset markets are incomplete. The model predicts that default incentives and interest rates are
higher in recessions, as observed in the data. The reason is that in a recession, a risk averse borrower finds it more costly to repay non-contingent debt and is more likely to default. In a quantitative exercise the model matches various features of the business cycle in Argentina
such as: high volatility of interest rates, higher volatility of consumption relative to output, a negative correlation of interest rates and output and a negative correlation of the trade balance and output. The model can also predict the recent default episode in Argentina.

/pdf/default-risk-and-income-fluctuations-in-emerging-economies-3uwetnmpe6.pdf

Default Risk and Income Fluctuations in Emerging Economies

A number of studies have stressed the role of movements in US interest rates and country spreads in driving business cycles in emerging market economies At the same time, country spreads have been found to respond to changes in both the US interest rate and domestic conditions in emerging markets These intricate interrelationships leave open a number of fundamental questions: Do country spreads drive business cycles in emerging countries or vice versa, or both? Do US interest rates affect emerging countries directly or primarily through their effect on country spreads? This paper addresses these and other related questions using a methodology that combines empirical and theoretical elements The main findings are: (1) US interest rate shocks explain about 20 percent of movements in aggregate activity in emerging market economies at business-cycle frequency (2) Country spread shocks explain about 12 percent of business-cycle movements in emerging economies (3) About 60 percent of movements in country spreads are explained by country-spread shocks (4) In response to an increase in US interest rates, country spreads first fall and then display a large, delayed overshooting; (5) US-interest-rate shocks affect domestic variables mostly through their effects on country spreads (6) The fact that country spreads respond to business conditions in emerging economies significantly exacerbates aggregate volatility in these countries (7) The US-interest-rate shocks and country-spread shocks identified in this paper are plausible in the sense that they imply similar business cycles in the context of an empirical VAR model as they do in the context of a theoretical dynamic general equilibrium model of an emerging market economy

Country Spreads and Emerging Countries: Who Drives Whom?

Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

/pdf/a-general-equilibrium-model-of-sovereign-default-and-2t8y4pn173.pdf

A General Equilibrium Model of Sovereign Default and Business Cycles

http://repec.org/sed2005/up.3900.1105404406.pdf

Sovereign default and debt renegotiation

https://www.frbsf.org/economic-research/files/wp04-32bk.pdf

Country spreads and emerging countries: Who drives whom?

https://www.nber.org/system/files/working_papers/w13588/w13588.pdf

Vivian Z. Yue

Papers

Country Spreads and Emerging Countries: Who Drives Whom?

A General Equilibrium Model of Sovereign Default and Business Cycles

Sovereign default and debt renegotiation

Country spreads and emerging countries: Who drives whom?

Global Yield Curve Dynamics and Interactions: A Dynamic Nelson-Siegel Approach