"The Sources of Macroeconomic Fluctuations in Developing Countries: Brazil and Korea"

The Sources of Macroeconomic Fluctuations
in Developing Countries: Brazil and Korea
by Alexander W. Hoffmaister and Jorge E. Roldós

This paper focuses on the sources of macroeconomic fluctuations in
small open economies. In addition to assessing the relative
importance of domestic demand and supply shocks, the methodology
allows an evaluation of the role of external shocks. To identify the
sources of business cycles, a set of block exogeneity restrictions is
added to the usual long-run restrictions that constrain the effects of
aggregate demand and nominal shocks on the level of output. To
justify the long-run restrictions as well as to interpret the
empirical results, the paper models an economy that produces an
exportable and a nontradable good using an imported intermediate
input. This model incorporates the effect of oil price shocks, world
output fluctuations, and structural reforms. The data determine the
short-run dynamics without specifying such frictions as price
rigidities, adjustment costs, and information restrictions that are
responsible for keeping output within the production possibilities
frontier. Thus, the empirical strategy encompasses a wide class of
macroeconomic paradigms in a unified framework.

Because structural reforms are essentially supply shocks, while
stabilization policies are basically demand shocks, the analysis
contributes to the understanding of the output and real exchange rate
effects of adjustment programs. In this vein, the empirical framework
compares the performance of Brazil and Korea. These representative
middle-income countries followed similar trade and macroeconomic
policies until the end of the 1970s, but their policies took different
directions in the 1980s.

The main results in this paper confirm, for small open economies,
the stylized fact found for the U.S. economy: supply shocks tend to
dominate output fluctuations even in the short run. In Brazil demand
policies play an important role in explaining the short-run
fluctuations of output and the real exchange rate, but in Korea the
effects of these policies are negligible. Unlike other studies, this
study finds that, controlling for domestic and supply shocks, external
factors play a limited role. External factors tend to account for
less than 20 percent of the fluctuations in GDP for both countries.
Finally, although fiscal policy shocks appear to be the main driving
force of real exchange rates, nominal shocks have almost no effect on
these rates.