Output Volatility and Large Output Drops in Emerging Market and Developing Countries

IMF Working Papers, May 1, 2007

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The paper establishes that output volatility and the size of output drops have declined across all countries over the past three decades, but remain considerably higher in developing countries than in industrial countries.
The favorable trends in output volatility and large output drops in developing countries are found to result from lower country-specific volatility and more benign country-specific events.
Evidence from cross-section regressions over the 1970-2003 period suggest that discretionary fiscal spending volatility, and terms of trade volatility together with exchange rate flexibility are key determinants of volatility and large output drops.

Employs a Bayesian latent dynamic factor model to decompose output growth into:
- global component,
- regional component,
- country-specific component.

Declining trends:
- Output volatility has declined across all countries over the past three decades.
- The size of output drops has declined across all countries over the past three decades.
Cross-country differences:
- Developing countries continue to experience considerably higher output volatility and larger output drops than industrial countries.
Drivers of improvement in developing countries:
- Improvements are attributed to lower country-specific volatility and more benign country-specific events (idiosyncratic factor).

Based on cross-section regressions covering the 1970-2003 period:
- Discretionary fiscal spending volatility is a key determinant.
- Terms of trade volatility is a key determinant.
- Exchange rate flexibility, together with terms of trade volatility, is a key determinant.

Subject: Emerging and frontier financial markets, Exchange rate flexibility, Fiscal policy, Production growth, Terms of trade
Keywords: CFA country, developing country region, idiosyncratic factor, output volatility, terms of trade volatility, WP

Source: IMF Working Paper “Output Volatility and Large Output Drops in Emerging Market and Developing Countries” by Dalia S Hakura, May 1, 2007.