Business cycle implications of rising household credit market participation in emerging countries

Abstract

A small open emerging-economy model is extended with a household sector financial constraint to investigate business cycle implications of a rise in household access and use of financial services. Estimating the model on Mexican data and consistent with empirical findings, this paper finds that a rise in household credit market participation: (1) yields larger aggregate consumption volatility and (2) amplifies the effects of shocks in the domestic economy, particularly those transmitted through the interest rate channel. The estimated model also highlights that: (3) the lesser financial frictions are, the lower is the increase of consumption growth and trade balance volatility driven by a rise in household credit market participation and (4) trend productivity shocks become a more relevant source of business cycle fluctuations. Finally, standard measures of predictive accuracy suggest that the extended model outperforms the baseline emerging market model.