A Country-Risk Approach to the Business Cycle: With an Application to Argentina

Serie Documentos de Trabajo, Documento No. 435

24 Pages Posted: 5 Dec 2010 Last revised: 7 Dec 2010

Date Written: November 1, 2010

Abstract

The paper holds that the country risk premium is the triggering factor of the business cycle in a small, financially open and highly volatile economy like that of Argentina. A rise of the premium determines a capital outflow, an aggregate demand contraction and a recession; a fall of the premium determines a capital inflow, an aggregate demand expansion and a boom. We build a model where country risk plays a central role in acroeconomic equilibrium. We evaluate the empirical relationship between country risk and GDP, consumption, investment, and the current account balance. We compare our country-risk model with those of various schools of macroeconomic thought. Main conclusions are: a) Country-risk perceptions of foreign and local investors determine the fraction of world income they like to spend in the small country and the country’s GDP adjusts passively to that fraction. b) Country risk causes a sort of labor unemployment that resembles involuntary unemployment. c) Openness softens the impact of a rise in country risk. d) Argentine time series for the period 1985-97 show a strong negative correlation between country risk and those aggregate variables, with causality going from the former to the latter.

JEL Classification: E32, F41

Suggested Citation

Avila, Jorge C., A Country-Risk Approach to the Business Cycle: With an Application to Argentina (November 1, 2010). Serie Documentos de Trabajo, Documento No. 435. Available at SSRN: https://ssrn.com/abstract=1719574 or http://dx.doi.org/10.2139/ssrn.1719574

Jorge C. Avila (Contact Author)

Universidad del CEMA ( email )

1054 Buenos Aires
Argentina
5411 6314-3000 (Phone)

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