Interest Rates and Real Business Cycles in Emerging Markets

Abstract

We study the quantitative effects of interest rates on the business cycles of emerging markets. The real business cycle model featured in Neumeyer and Perri (“Business cycles in emerging economies: The role of interest rates.” Journal of Monetary Economics, March 2005, 52 (2), 345-380.) is calibrated to match Turkish data. Fluctuations in country spread account for only less than 9 percent of output volatility, less than one-third of the value found in Neumeyer and Perri. We show that their result critically depends on the magnitude of the working capital parameter, the persistence of productivity shocks, and the factor shares. Our simulations highlight the importance of country spreads for the volatility of investment and the cyclicality of net exports. We also discuss the effect of correlated shocks on the countercyclicality of real interest rate and net exports.