Essays on Business Cycles in Developing Countries

Abstract

My dissertation consists of three papers on business cycles in developing countries. All the papers are different from each other and emphasize different aspects of understanding economic fluctuations in developing countries. The first paper is titled `Medium Term Business Cycles in Developing Countries' (with Diego Comin, Norman Loayza and Luis Serven). This paper models the link between business cycle fluctuations in developed countries with fluctuations in developing countries. Business cycle fluctuations in developed economies tend to have large and persistent effects on developing countries. We study the transmission of business cycle fluctuations from developed to developing economies with a two-country asymmetric DSGE model with two important features: (i) endogenous and slow diffusion of technologies from the developed to the developing country, and (ii) adjustment costs to investment flows. Consistent with the model, we observe that the flow of technologies from developed to developing economies co-moves positively with output in both developed and developing countries. After calibrating the model to Mexico and the U.S., it can explain the following stylized facts: (i) U.S. and Mexican output co-move more than consumption; (ii) U.S. shocks have a larger effect on Mexico than in the U.S.; (iii) U.S. business cycles lead over medium term fluctuations in Mexico; (iv) Mexican consumption is more volatile than output. The second paper of my dissertation is based on a price setting survey conducted by the State Bank of Pakistan (Central Bank). The paper is titled `Price-Setting Discoveries: Results from a Developing Country' (with M. Ali Choudhary, Abdul Faheem, Nadeem Hanif, and Saima Naeem) present the results of 1189 structured face-to-face interviews about price-setting behavior of the formal firms in the manufacturing and services sector of Pakistan. The key findings of the survey are:the frequency of price change is high in Pakistan, lowering the real impact of monetary policy. Price rigidity is mainly explained by firms caring about relative prices and the persistence of shocks. The exchange-rate and cost shocks are more important than financial and demand shocks for both setting prices and also the readiness with which these shocks pass-through to the economy. Formal sector firms with connections to the informal sector, especially through demand, have a lower probability of price adjustment. The lack of taxes and compliance with tax regime, i.e. enforcement are held responsible for existence of the informal sector by formal sector firms. The results from this paper provided motivation for the last paper of my dissertation about understanding and modeling the business cycle fluctuations in a developing economy like Pakistan. The last paper of my dissertation is titled `Modeling Business Cycles in Pakistan: A First Step'. In this paper, I establish the nature of short-run fluctuations of the Pakistani economy over the period of 1960-2010. There have been significant changes in the nature of the Pakistani economy over the last few decades. Therefore, I focus my detailed analysis on the last few decades where it seems more appropriate to investigate the nature and causes of business cycles in Pakistan. Furthermore, I evaluate the performance of a typical RBC and an augmented RBC model with an exogenous FDI shock in explaining cyclical fluctuations experienced by the Pakistani economy. I find that a simple RBC model does badly in terms of matching relevant second order moments of short run fluctuations as depicted by the data. However, augmented RBC model performs better compared to the simple RBC model.