Durable goods, financial frictions, and business cycles in emerging economies

Business cycles in emerging economies display very volatile consumption and strongly countercyclical trade balance. We show that aggregate consumption in these economies is not more volatile than output once durables are accounted for. Then, we present and estimate a real business cycles model for a small open economy that accounts for this empirical observation. Our results show that the role of permanent shocks to aggregate productivity in explaining cyclical fluctuations in emerging economies is considerably lower than previously documented. Moreover, we find that financial frictions are crucial to explain some key business cycle properties of these economies.