Financial Frections And Business Cycles In Middle Income Countries

Standard DSGE small open economy models can not generate the cyclical properties of Middle-Income Countries (MICs). These models, compared to the data, predict excessive consumption smoothing, low procyclicality of investment and procyclical, instead of counter cyclical, real net exports. Previous studies have solved this problem by increasing the persistence of shocks or by lowering the intertemporal elasticity of substitution. This paper tackles it by introducing market imperfections relevant for MICs into an otherwise standard model.