Home Production and Small Open Economy Business Cycles

Chen, Kuan-Jen and Chu, Angus C. and Lai, Ching-Chong (2014): Home Production and Small Open Economy Business Cycles.

Abstract

This paper incorporates home production into a real business cycle (RBC) model of a small open economy to provide a parsimonious explanation of the empirical pattern of international business cycles in developed economies and emerging markets. It is well known in the literature that in order for the RBC model to replicate quantitatively plausible empirical moments of small open economies, the model needs to feature counterfactually a small income effect on labor supply. This paper provides a plausible solution to this puzzle by considering home production that introduces substitutability between market consumption and home consumption, which in turn generates a high volatility in market consumption in accordance with the data, even in the presence of a sizable income effect on labor supply. Furthermore, the model with estimated parameter values based on the simulated method of moments is able to match other empirical moments, such as the standard deviations of output, investment and the trade balance and the correlations between output and other standard macroeconomic variables. Given that home production is more prevalent in emerging markets than in developed economies, the model is also able to replicate empirical differences between emerging markets and developed economies in the volatility of market consumption and the volatility/countercyclicality of the trade balance.

• Item Type: MPRA Paper
• Language: English
• Keywords: small open economy; home production; emerging markets; business cycles
• Subjects: D - Microeconomics > D1 - Household Behavior and Family Economics > D13 - Household Production and Intrahousehold Allocation; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development > O16 - Financial Markets ; Saving and Capital Investment ; Corporate Finance and Governance

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