Sources of emerging market business cycles: an open-economy factor-augmented VAR approach

Abstract

This paper constructs an open-economy factor-augmented VAR model to assess the dynamic effects of global shocks on emerging market economies and to quantify their relative importance in explaining macroeconomic fluctuations in emerging countries. An unexpected favourable shock to global demand and supply has a strong and positive effect on emerging markets, whereas an unanticipated rise in global interest rates and commodity prices leads to a significant decline in aggregate activity. Variance decomposition analysis implies that more than 80% of the variation in emerging market output growth can be attributed to the global shocks. In particular, the global demand shock is the most critical, explaining roughly 30% of the fluctuation in output growth. The global supply shock is closely associated with the medium-to-long-term variation in output growth, explaining about 17%, whereas the monetary policy and commodity price shocks are relatively relevant for the short-term variation, explaining about 20% respectively.