Altig, D., L. Christiano, M. Eichenbaum, and J. Lindé, 2005, “Firm-Specific Capital, Nominal Rigidities and the Business Cycle,” NBER Working Paper No. 11034.
D. Backus, P. Kehoe and F. Kydland, 1994, “Relative Price Movements in Dynamic General Equilibrium Models of International Trade,” in: R. van der Ploeg (Eds.) Handbook of International Macroeconomics, Wiley-Blackwell, pp. 62–96.
Baxter, M. and M. Crucini, 1995, “Business Cycles and the Asset Structure of Foreign Trade,” International Economic Review, Vol. 36, pp. 821–54.
Chari, V.V., P. Kehoe and E. McGrattan, 2002, “Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?,” Review of Economic Studies, Vol. 69, pp. 533–563.
Corsetti, G., L. Dedola and S. Leduc, 2008a, “International Risk Sharing and the Transmission of Productivity Shocks,” Review of Economic Studies, Vol. 75, pp. 443–473.
Corsetti, G., L. Dedola and S. Leduc, 2008b, “High Exchange Rate Volatility and Low Pass-through,” Journal of Monetary Economics, Vol. 55, pp. 1113–28.
Christoffel, K., K. Kuester, and T. Linzert, 2009, “The Role of Labor Markets for Euro Area Monetary Policy,” European Economic Review, Vol. 53, pp. 908–36.
Engle R. and C. Granger, 1987, “Co-Integration and Error Correction: Representation, Estimation, and Testing,” Econometrica, Vol. 55, pp. 251–76.
Engel, C. and A. Matsumoto, 2009, “The International Diversification Puzzle When Goods Prices Are Sticky: It’s Really about Exchange-Rate Hedging, Not Equity Portfolios,” American Economic Journal: Macroeconomics, Vol. 1, pp. 155–88.
Fisher, J., 2006, “The Dynamic Effects of Neutral and Investment-Specific Technology Shocks,” Journal of Political Economy, Vol. 114, pp. 413–51.
García-Cicco J., R. Pancrazi, and M. Uribe “Real Business Cycles in Emerging Countries?,” American Economic Review, forthcoming..
Greenwood, J., Z. Hercowitz, and G. Huffman, 1988, “The Role of Investment-Specific Technological Change in the Business Cycle,” European Economic Review, Vol. 44, pp. 91–115.
Heathcote, J., and F. Perri, 2002, “Financial Autarky and International Business Cycles,” Journal of Monetary Economics, Vol. 49, pp. 601–27.
Heathcote, J., and F. Perri, 2007, “The International Diversification Puzzle Is Not as Bad as You Think,” NBER Working Paper No. 13483.
Ireland, P., 2009, “Stochastic Growth in the United States and the Euro Area,” Boston College Working Papers in Economics No. 713.
Johansen, S., 1991, “Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models,” Econometrica Vol. 59, pp. 1551–80.
Justiniano, A., G. Primicieri and A. Tambalotti, 2008, “Investment Shocks and Business Cycles,” Federal Reserve Bank of New York Staff Report No. 322.
King, R., C., Plosser and S., Rebelo, 1988, “Production, Growth and the Business Cycle,” Journal of Monetary Economics, Vol. 21, pp. 195–232.
MacKinnon, J., A. Haug and L. Michelis, 1999, “Numerical Distribution Functions of Likelihood Ratio Tests for Cointegration,” Journal of Applied Econometrics, Vol. 14 (5), pp. 563–77.
Ng, S. and P. Perron, 2001, “LAG Length Selection and the Construction of Unit Root Tests with Good Size and Power,” Econometrica Vol. 69, pp. 1519–54.
Rabanal, P., J. Rubio-Ramírez, and V. Tuesta, 2010, “Cointegrated TFP Processes and International Business Cycles,” revised version of Federal Reserve Bank of Atlanta Working Paper 2009-23.
Raffo, A., 2008, “Net exports, Consumption Volatility and International Business Cycle Models,” Journal of International Economics, Vol. 75, pp. 14–29.
Stockman, A., L. Tesar, 1995, “Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements,” American Economic Review, Vol. 85, pp. 165–85.
We thank Martín Uribe, Jesper Lindé an anonymous referee, and seminar participants at SCIEA at the Federal Reserve Bank of Dallas for very helpful comments and suggestions. Beyond the usual disclaimer, we must note that any views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, FEDEA, or the International Monetary Fund. Finally, we also thank the NSF for financial support. Federico Mandelman is an economist at the Federal Reserve Bank of Atlanta, Research Department, Pau Rabanal is an economist in the Research Department of the IMF, Juan Rubio-Ramirez is an associate professor at Duke University, and Diego Vilán is a graduate student at the University of Southern California.
Behind our exercise lies the assumption that basic IRBC models do a good job fitting the data. Some authors doubt it. For example García-Cicco et. al. (2009) report that the RBC model does a poor job at explaining business cycles in emerging countries. They also find that only a richer model with country premium shocks and financial frictions can account for the business cycles in emerging markets.
Some important exceptions are Rabanal et al. (2010), Ireland (2009), and Engel and Matsumoto (2009). It is also important to mention that Baxter and Crucini (1995) was the first paper to consider permanent shocks and the possibility of cointegration in the context of this class of models. The reason they did not pursue the VECM specification was that the evidence of cointegration was mixed for the bilateral pairs they studied.
We will consider two types of utility functions when analyzing the results in Section IV.. The standard Cobb-Douglas case, as in Heathcote and Perri (2002), and the GHH preferences as in Raffo (2009).
The Φ(·) cost is introduced to ensure stationarity of the level of D(st) in IRBC models with incomplete markets, as discussed by Heathcote and Perri (2002). We choose the cost to be numerically small, so it does not affect the dynamics of the rest of the variables.
The Johansen (1991) test rejects the existence of a cointegration relationship if we allow for a trend in the VAR or we do not allow for a constant in the cointegration relationship.
We do normalize the (log) IST shocks so that the constant takes a value equal to zero. Hence, we do not report it.
Rabanal et al. (2010) use a model in which technology innovations are labor augmenting:
The labor supply elasticity for the Cobb-Douglas (εCD) and GHH specifications (εGHH) are defined as follows:
Notice that if
In fact, we choose ϕ so that the volatility of investment matches the data when ρV = 0.97 (model M3 to be seen next) since this is the parametrization that is closest to Raffo (2009).
Note that in this case we do not consider investment adjusment costs. Since our estimated IST shocks have a smaller variance than the ones used by Raffo (2009) we do not need to include them to dampen the response of investment. Actually, zero adjustment costs will deliver a relative standard deviation of investment that is lower than the one observed in the data.
We are thankful to K. Christoffel and K. Kuester for providing us with the data.