Interest Rates and Business Cycles in Emerging Economies: The Role of Financial Frictions

51 Pages Posted: 17 Feb 2013

See all articles by Andrés Fernàndez

Andrés Fernàndez

Inter-American Development Bank (IDB) - Research Department

Adam Gulan

Bank of Finland - Research

Multiple version iconThere are 2 versions of this paper

Date Written: November 2012

Abstract

Countercyclical country interest rates have been shown to be both a distinctive characteristic and an important driving force of business cycles in emerging market economies. In order to account for this, most business cycle models of emerging market economies have relied on ad hoc and exogenous countercyclical interest rate processes. This paper embeds a financial contract à la Bernanke et al. (1999) in a standard small open economy business cycle model that endogenously delivers countercyclical interest rates. The model is then applied to the data, drawn from a novel panel dataset for emerging economies that includes financial data, namely sovereign and corporate interest rates as well as leverage. It is shown that the model accounts well not only for countercyclical interest rates, but also for other stylized facts of emerging economies` business cycles, including the dynamics of leverage.

JEL Classification: E32, E44, F41

Suggested Citation

Fernandez, Andres and Gulan, Adam, Interest Rates and Business Cycles in Emerging Economies: The Role of Financial Frictions (November 2012). IDB Working Paper No. IDB-WP-339, Available at SSRN: https://ssrn.com/abstract=2219776 or http://dx.doi.org/10.2139/ssrn.2219776

Andres Fernandez (Contact Author)

Inter-American Development Bank (IDB) - Research Department ( email )

1300 New York Ave., NW
Washington, DC 20577
United States

Adam Gulan

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

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