Business Cycles in Emerging Markets: the Role of Durable Goods and Financial Frictions

There is a growing literature studying business cycles in emerging economies. This paper contributes to this literature by examining how durable goods and financial frictions shape cyclical fluctuations in a small open economy subject to transitory and permanent shocks. We find that permanent shocks play a less important role driving the cycle in emerging economies than previously documented. We also find that financial frictions are crucial to explain some key business cycle properties of these economies. In our quantitative model, a countercyclical borrowing premium interacts with the purchase of durables to deliver highly volatile consumption and strongly countercyclical net exports.