Emerging Market Business Cycles : The Cycle is the Trend

We document and contrast features of the business cycle for emerging markets and developed small open economies. Current accounts are shown to be more strongly countercyclical and consumption is more volatile relative to income in emerging markets. Next we show that a standard dynamic stochastic small open economy model can account for the behavior of both types of markets once we appropriately model the decomposition of underlying productivity shocks into permanent and transitory shocks. When calibrated to the income process for each type of economy, we find that the predominance of shocks to trend growth relative to transitory shocks for emerging markets and the reverse for developed markets explains differences in key features of their business cycles. Lastly, we document empirically that shocks to trend generate a preponderance of income variance at business cycle frequencies in emerging markets, supporting the notion that the "cycle is the trend" for these economies