Emerging Market Business Cycles With Remittance Fluctuations

Abstract

This paper analyzes the implications of remittance fluctuations for various macroeconomic variables and sudden stops. The paper employs a quantitative two-sector model of a small open economy with financial frictions calibrated to Mexican and Turkish economies, two major recipients, whose remittance receipts feature opposite cyclical characteristics. We find that remittances dampen business cycles in Mexico, whereas they amplify the cycles in Turkey. Their quantitative effects in the long run, approximated by the stochastic steady state, are mild. In the short run, however, remittances have quantitatively large impacts on the economy, when the economy is borrowing-constrained. This is because agents in the economy cannot adjust their precautionary wealth to sudden tightening in credit, and hence, fluctuations in remittances get magnified through an endogenous debt-deflation mechanism. The findings suggest that procyclical (or countercyclical) remittances can play a significant deepening (or mitigating) role for sudden stops. [JEL F41, F32, E32] IMF Staff Papers (2010) 57, 303-325. doi:10.1057/imfsp.2009.3; published online 15 December 2009