Investment-Specific Shocks and Real Business Cycles in Emerging

Economies: Evidence from Brazil

Eurilton Araújo
Insper Institute
Rua Quatá, 300
04546-042 São Paulo-SP
euriltona@insper.org.br

Abstract
This paper investigates the role of the RBC (Real Business Cycle) model with investment-
specific technology shocks in explaining business cycle fluctuations in Brazil. I consider
the role of transitory and permanent components of neutral and investment-specific
technology shocks. I fit the model to the data using Bayesian techniques to show that the
permanent components of neutral and investment-specific shocks are the major sources of
fluctuations. In fact, investment-specific shocks can account for remarkable percentages of
fluctuations in GDP growth, investment growth and trade balance to GDP ratio.
Furthermore, I present simulation evidence showing that the RBC model cannot account for
some important features of the data.

Keywords: investment-specific shocks, business cycles, Brazil

JEL Classification: C11, E32, F41

1. Introduction

In this paper, I investigate the role of investment-specific technology shocks for

business cycle fluctuations in Brazil. The main goal is to gauge the importance of

investment-specific technology shocks as a source of macroeconomic fluctuations in the

context of the standard Real Business Cycle (RBC) tradition in which fluctuations are

explained by means of technology shocks in an environment without frictions. The artificial

economy has two types of technology shocks: neutral shocks and investment-specific

shocks. Neutral shocks affect the production of all goods homogeneously, and investment-

1
specific shocks affect only investment goods. I consider the role of transitory and

permanent components of each shock in accounting for Brazilian business cycles.

In a recent paper, Aguiar and Gopinath (2007) suggest that emerging market

business cycles result from permanent and transitory shocks to productivity. They find that

the permanent component of a neutral technology shock is very important to account for

macroeconomic fluctuations in Mexico. They interpret the shocks to trend as dramatic

changes in institutions and policy in emerging economies. They also analyze the case of a

small open developed economy, namely Canada. In contrast to the results for Mexico,

transitory shocks are more important for Canada than trend shocks.

Garcia-Cicco, Pancrazi, and Uribe (2007) point out that the identification of

permanent shifts in productivity is difficult using short samples. They use more than one

century of Argentinean data to conclude that the model described in Aguiar and Gopinath

(2007) is not capable of accounting for the dynamics of the trade balance. In addition, they

find a smaller role for the permanent component of the neutral technology shock. This

evidence suggests that business cycles in emerging markets cannot be explained solely by

technology shocks as in the RBC tradition. However, none of these papers addresses the

role of shocks to the marginal efficiency of investment in driving emerging market business

cycles in a simple RBC model without additional frictions. Therefore, it may still be

possible to describe business cycles as driven by technology shocks, if the model allows for

different types of technology shocks.

The findings in Greenwood, Hercowitz, and Huffman (1988); Greenwood,

Hercowitz, and Krusell (1997 and 2000); and Fisher (2006) stress the importance of

investment-specific technology shocks as a source of growth and macroeconomic

fluctuations in the US. Greenwood, Hercowitz, and Krusell (1997) focus on the importance

2
of this kind of shock for economic growth by performing a growth accounting exercise.

This study finds that approximately 60% of growth in aggregate output per men-hour is due

to investment-specific technological change. In Greenwood, Hercowitz, and Krusell (2000),

the same authors investigate the role of investment-specific technological change in

business cycle in a calibrated Neoclassical Model. The results indicate that this form of

technological change is the source of 30% output fluctuations. This is an impressive

number given that investment in equipment, the major source of this kind of technological

change, amounts to approximately 7% of US GNP. Fisher (2006) builds a RBC model, with

the two types of technology shocks, in order to generate economic restrictions capable of

identifying the two types of technology shocks in a Structural Vector Auto-regression

system (SVAR). Again, the results show the importance of technology shocks for

economic fluctuations. Moreover, investment-specific technology shocks account for the

majority of the effects of technology shocks on economic fluctuations.

More elaborated Dynamic Stochastic General Equilibrium (DSGE) Models, such as

Pakko (2002), Guerrieri, Henderson and Kim (2005), and Ireland and Schuh (2008), rely on

investment-specific technology shocks to understand the historical evolution of total factor

productivity in the US. Guerrieri, Henderson, and Kim (2005) document the increase in

productivity growth in information and communication technology (ICT) both in Europe

and in the US. To study the effects of productivity growth in the ICT sector in the US and

Europe, they build a two-country general equilibrium model in which productivity in the

ICT sector is associated with investment-specific technological change. This is in line with

Greenwood, Hercowitz, and Krusell (1997 and 2000) who emphasizes investments in new

equipments rather than in structures as the source of investment-specific technical change.

Justiano, Primiceri, and Tambalotti (2008) show that investment shocks are extremely

3
important for US business cycles in a DSGE model with nominal rigidities. Letendre and

Luo (2007) study the effects of transitory investment-specific shocks in a small open

economy calibrated to Canadian data. They find that this type of shock enhances the ability

of the model to replicate the dynamic behavior of trade-related variables, especially the

auto-correlation of the trade balance and the correlation between the output and the trade

balance.

Recent studies that build RBC models to understand Brazilian business cycles, such

as Ellery Jr., Gomes, and Sachsida (2002); and Bugarin et al. (2007), have only considered

the role of neutral technology shocks. Nonetheless, they show that the Neoclassical Model

can explain growth and business cycle fluctuations in Brazil. Historically, investment-

specific shocks may have played a potentially important role since the Brazilian

industrialization process that starts in the 1930’s and increases significantly after de World

War II, , as discussed in Baer(2008), was based on promoting growth in durable goods and

machinery through special government programs. The emerging automobile industry in the

1950s is the standard example of the Brazilian industrialization strategy based on the

substitution of imports and investment in new equipments and machinery.

In recent years, openness to trade and the effects of deregulations and privatizations

in the 1990s, as documented by Schimitz and Teixeira (2008), have increased productivity

in Brazil. In fact, it is plausible that part of that increase is due to new equipments and

increasing marginal efficiency of investment. More recently, with an increase in the rate of

adoption of ICT technology, as documented in Basant et al. (2007), a study using firm-level

data for Brazil and India, emerging market countries, and especially Brazil, tend to see a

potentially greater role of investment-specific technology change as an alternative source of

business cycles.

4
 INSERT FIGURE 1

INSERT FIGURE 2

Figures 1 and 2 motivate more concretely the potential importance of investment-

specific technology shocks. Figure 1 shows an increasing pattern in the component of

investments related to equipments and machinery from 1901 to 2006. Investment in new

equipments and machines start growing around 1945, with increasing efforts to bring about

industrialization in Brazil. In a period known as the Brazilian “miracle”, the 1960’s and

1970’s, the growth was extremely fast. During the “lost decade” of the 1980’s, we see a

clear decrease; and since the mid 1990’s, a recovery has been taken place. Figure 2 shows

the time series of the relative price of investment in equipment and machinery in terms of

non-durable consumption goods from 1970 to 2007. Unfortunately, data from 1901 to 1969

is not available. The decline in this relative price, shown in Figure 2, is in line with the

empirical evidence reported in Greenwood, Hercowitz, and Krusell (2000) for the US.

Letendre and Luo (2007) describe the same pattern for Canada. In spite of the bad

economic performance of the 1980’s, the negative co-movement between the relative price

and investment in equipments, at least in the 1970’s and in the 1990’s, suggests that there

have been significant technological advances embodied in new capital goods.

I study a small open economy version of the model studied in Fisher (2006) with

variable capital utilization in the tradition of Greenwood, Hercowitz, and Huffman (1988). I

consider, as Aguiar and Gopinath (2007), shocks to levels and growth rates. In line with

Garcia-Cicco, Pancrazi, and Uribe (2007), I use annual time series from 1947 to 2007 to

improve the identification of growth rate shocks. However, instead of deriving restrictions

to identify a SVAR, I directly estimate the structural parameters of the RBC model, which

5
includes the autoregressive coefficients and variances of all types of shocks, employing

Bayesian methods.

The structural full-information macroeconometric approach has recently become a

viable alternative to calibration and limited-information methods. Ireland and Schuh

(2008) perform structural estimation of a two-sector RBC model via maximum likelihood.

Dejong, Ingram, and Whitman (2000) perform Bayesian structural estimation of a closed-

economy RBC model featuring transitory neutral and investment-specific technology

shocks for the US. Justiano, Primiceri, and Tambalotti (2008) also perform structural

Bayesian estimation of a medium-scale new Keynesian model featuring investment shocks

and a myriad of alternative sources of fluctuations.

In addition to the structural econometric exercise, I simulate the model under the

estimated parameter values in order to gauge the importance of investment-specific

technology shocks vis-à-vis neutral technology shocks as a source of macroeconomic

fluctuations.

The findings indicate that the permanent components of neutral and investment-

specific shocks are important sources of business cycle fluctuations in Brazil. Investment-

specific shocks are the most important source of fluctuations for the trade balance to output

ratio, investment growth and output growth. Neutral shocks are the most important source

of fluctuations for consumption growth. These findings are in line with Aguiar and

Gopinath (2007). As shown in Garcia-Cicco, Pancrazi, and Uribe (2007) for Argentina, the

model cannot match stylized business cycle second moment statistics, especially the ones

related to the trade balance to output ratio. The evidence that frictionless real business cycle

models cannot account for business cycle fluctuations in emerging markets long annual

data sets is also present in the Brazilian case.

6
 The paper contains four additional sections. Section 2 describes the small open

economy version of the RBC model presented in Fisher (2006). Section 3 discusses the

Bayesian techniques and the data used for estimation. Section 4 presents the findings.

Finally, Section 5 offers some concluding remarks.

2. The Model

In this section, I describe a small open economy RBC model with variable capital

utilization and two shocks, one to the general technology and another to investment, as

specified in Fisher (2006). However, different from Fisher (2006), and in accordance with

Ireland and Schuh (2008), as well as Aguiar and Gopinath (2007), I consider distinct shock

specifications for the logs of the levels and the growth rates of both shocks. In the short run,

both components of each shock affect aggregate variables. The long run implications of

both shocks for macroeconomic variables depend on growth rate components. In sum, I

consider stationary shocks to the level and growth of neutral and investment-specific

technology shocks to account for the short run and the long run impacts of both shocks on

macroeconomic dynamics.

To describe the economic environment, it is sufficient to present the social planner’s

problem, since the Welfare theorems hold. The social planner chooses consumption ( Ct ),

investment ( X t ), hours worked ( H t ), household private debt position ( Dt ), the rate of

capacity utilization ( U t ), and next period’s capital stock ( K t +1 ) to

∞
maximize E 0 ∑ β t [log(C t ) − H t ] , the inter-temporal utility function of a representative
t =0

household, subject to the following constraints:

7
 2
φ  K t +1  Kt
Dt = (1 + Rt −1 ) Dt −1 − Yt + C t + X t +  − µ  (1)
2  Kt  Vt

K t +1 = (1 − δ (U t )) K t + Vt X t (2)

δ 0U tη
δ (U t ) = (3)
η

Yt = At (U t K t ) α H t1−α (4)

Dt
Rt = R * + ψ [exp( − d ) − 1] (5)
Z t −1

Equation (1) describes the dynamics of debt position. Equation (2) governs capital

accumulation in this economy. According to (3), the rate of depreciation δ is a function of

the rate of capacity utilization. The production function is specified according to (4).

Finally, according to (5), the small open RBC is closed with an external debt-elastic interest

rate to induce independence of the deterministic steady state to initial debt positions. This

specification is in line with Aguiar and Gopinath (2007) and Garcia-Cicco, Pancrazi, and

Uribe (2007). The variable Dt denotes the aggregate external debt per capita, taken as

exogenous by the household. The equality Dt = Dt holds in equilibrium. Since the model is

non-stationary because of the presence of two unit roots in the permanent component of

each shock and standard numerical solutions do not apply to models with stochastic trends,

1 α
the scale variable Z t −1 = ( Atg−1 ) 1−α (Vt −g1 ) 1−α is needed to obtain a stationary solution. The

parameters β , α , and δ are the inter-temporal discount factor, the Cobb-Douglas technology

parameter and the depreciation rate, respectively. The parameters µ and d measure the

8
 K t +1 D
long-run average growth of and t , respectively. The parameter ψ measures the
Kt Z t −1

sensitivity of the interest rate to debt position.

The variables At and Vt are the neutral and the investment-specific technology

shocks, respectively. Each shock contains two separate auto-regressive components: a

stationary level disturbance (transitory component) and a stationary growth rate disturbance

(permanent component). The notation uses capital letters and the superscript g for growth

rate shocks; and small letters and the superscript l for level shocks. The following auto-

regressive processes characterize the logarithm of At and Vt :

ln( At ) = ln(atl ) + ln( Atg ) (6)

ln(atl ) = ρ al ln(atl−1 ) + eatl (7)

Atg Atg−1
ln( g
) = (1 − ρ g
a ) ln( a g
) + ρ g
a ln( g
) + eatg (8)
At −1 At −2

ln(Vt ) = ln(vtl ) + ln(Vt g ) (9)

ln(vtl ) = ρ vl ln(vtl−1 ) + evtl (10)

Vt g Vt −g1
ln( g
) = (1 − ρ g
v ) ln(v g
) + ρ g
v ln( g
) + evtg (11)
Vt −1 Vt − 2

The shocks eatl , eatg , evtl , and evtg are normally distributed with variances

(σ al ) 2 , (σ ag ) 2 , (σ vl ) 2 , and (σ vg ) 2 . The auto-regressive coefficients ρ al , ρ ag , ρ vl , and ρ vg

measure the persistence of each component of the two technology shocks and their absolute

values are less than one to guarantee that the processes are stationary. The average growth

rates of At and Vt are a g and v g , respectively.

9
 The optimality conditions are described in the appendix. To find a stationary

equilibrium, I define the following normalized

Ct D I Y Kt
variables: ct = , d t = t , it = t , yt = t , ht = H t , u t = U t , and k t = . The
Z t −1 Z t −1 Z t −1 Z t −1 Z t −1Vt −g1

transformed variables are stationary and standard numerical solutions can be applied to a

system of stochastic difference equations written in terms of these variables. The rate of

capacity utilization and hours worked are assumed to be stationary, therefore there is no

need of any transformation for these variables.

3. Empirical Methodology and Data

In this section, I briefly discuss the Bayesian approach to the estimation of DSGE

models. Then, I present the priors and the data used in the estimation.

3.1. Bayesian Methods

The use of Bayesian Methods to estimate DSGE models has increased over recent

years. An and Schorfheide(2007) survey the application of Bayesian techniques in

Structural Macroeconometrics. Under reasonable priors, Bayesian methods offer

advantages over alternative system estimators such as maximum likelihood, which is based

on the strong assumption that the DSGE model is the data-generating process. Thus, the

Bayesian approach can deal with potential misspecification problems in a better way than

maximum likelihood; and this is the main reason why it is a popular method among

empirical macroeconomists.

The vector Θ1 = ( β , α , δ 0 ,η , φ , µ , d ,ψ ) contains the parameters describing the

structure of the artificial economy and the vector

10
Θ 2 = ( ρ al , ρ ag , ρ vl , ρ vg , σ al , σ ag , σ vl , σ vg , a g , v g ) characterizes the technology shocks. We have

in total 18 parameters.

The equations that characterize the equilibrium conditions is presented in the

appendix, and can be written as the following system of rational expectations difference

equations GEt ( wt +1 ) = Hwt + Jet , in which the symbol E t denotes the expectation operator.

The matrices G, H and J are functions of the vector Θ = (Θ1 , Θ 2 ). The

vector wt = (d t , k t +1 , ht , u t , yt , ct , xt , rt ) contains the choice variables and et is a vector

containing transitory and permanent components of neutral and investment-specific shocks.

The solution of the system takes the form of a state space representation, in which

some variables are observed and others are not. Given a sample of observable variables,

denoted by YTobs , an econometrician computes the likelihood function p (YTobs | Θ) by means

of the Kalman Filter algorithm. Then, for any specification of the prior distribution p (Θ) ,

the posterior distribution for the parameters of the model, according to Bayes Theorem,

p(Θ) p (YTobs | Θ)
is p (Θ | YTobs ) = . The analytical computation of the posterior distribution is
p(YTobs )

almost impossible for complex models. In fact, an expression for p (YTobs ) is the result of

integrating p (Θ) p(YTobs | Θ) with respect to Θ. However, it is possible to obtain draws form

the unknown posterior through Bayesian simulation techniques such as the Metropolis-

Hastings algorithm, which is discussed in detail by An and Schorfheide(2007).

An advantage of the Bayesian method is the possibility of incorporating additional

information about the range of plausible values for the parameters through the specification

of the prior distribution. In fact, in DSGE models, past knowledge accumulated among

11
macroeconomists or restrictions coming from the equations describing the steady state

usually suggest reasonable ranges for the structural parameters.

Bayesian simulation techniques allow the econometrician to obtain draws from the

posterior distribution of the parameter vector. Therefore, it is possible to characterize

numerically the posterior distribution of any object that is a function of the parameters such

as variance decompositions, moments and impulse responses to shocks. These objects are

useful tools in assessing the economic significance of a model. In addition, the fit of a

particular model to the data can be measured by the marginal data density p (YTobs ) .

Moreover, model comparison, in the Bayesian framework, is done by means of posterior

odds ratio which is the ratio of marginal data densities for different models. In sum,

Bayesian methods allow the assessment of the economic and statistical significance of a

model in a flexible way.

3.2. The Priors

Table 1 summarizes the prior distributions for the parameters of the model. The

priors are independent across parameters. They reflect beliefs about reasonable values for

the parameters. These beliefs are based on existing prior research, especially from

calibrated open-economy DSGE models. In addition, prior specification takes in

consideration economic restrictions on some parameters. The degree of certainty about the

values of a particular parameter can be evaluated by the tightness of the prior. In fact, an

almost non-informative prior should be specified if there is little information available on

the value of a particular parameter.

12
 I use Normal, Beta, Gamma and Inverted-Gamma distributions for the parameters.

These distributions are centered in reasonable values, based on previous literature, cited in

the introduction, on RBC models applied to the Brazilian economy.

Some parameters are calibrated to standard values in the literature. This is the case if

the parameter in question is not crucial for the purpose of the paper, which is to explain

Business Cycle in Emerging Economies as driven only by technology shock and to gauge

the importance of investment-specific shocks in this context. I set ψ = 0.001 and d is set in

such a way that the steady state of the trade balance to output ratio takes the mean value

observed for that variable in as Ellery Jr., Gomes, and Sachsida (2002); and Bugarin et al.

(2007) the data (1.32%). Remaining calibrated parameters are β = 0.92, α = 0.4 . These

values are close to the ones used in Ellery Jr., Gomes, and Sachsida (2002) and Bugarin et

al. (2007). Steady state conditions impose restrictions on the parameters µ , δ 0 , d , R * . They

are functions of the average growth rates of At and Vt ( a g and v g ). Therefore, a g and v g are

estimated and the values of µ , δ 0 , d , R * can be recovered afterwards.

INSERT TABLE 1

3.3. The Data Set

To improve the identification of the permanent shocks I use annual time series from

1947 to 2007, following the suggestion in Garcia-Cicco, Pancrazi, and Uribe (2007). The

data are taken from IPEADATA, a Brazilian economic database. I use 4 time series in the

estimation: real per capita consumption, real per capita investment, real per capita GDP and

the trade balance to GDP ratio. The first differences of the series, in logarithmic scale, are

used in the estimation.

13
 Though, there are time series information starting in 1901 for GDP per capita, the

trade balance and some components of investments, I decide to work with a data set

beginning in 1947. This choice is based on the following reasons.

First, I can use more accurate information in the estimation since data on total

investment and consumption are not available prior to 1947. Second, without consumption

growth data, I cannot assess one important stylized fact in emerging economies business

cycles, that is consumption is more volatile than output. Third, historically, prior to 1947,

Brazil was predominantly an agrarian economy with a small stock of capital. Therefore, the

prototype RBC model is a priori not a good model to address macroeconomic fluctuations

prior to 1947, since it does not account explicitly for the role of land as an important

productive factor and emphasizes technology shocks as the driver of fluctuations, which

was not the case for Brazil in its pre-industrial stage. Fluctuations in this era were mainly

due to international commodity prices fluctuations, such as the price of coffee, rubber and

sugar.

4. Results

This section presents the estimates of the parameters of the model and the variance

decomposition, indicating the relative importance of each shock to each endogenous

variable. In addition, I present simulation results concerning second moment statistics.

4.1. Parameter Estimates

14
 Table 2 summarizes the posterior distributions for the parameters of the model.

There is not enough information in the data to shift the prior concerning the average growth

rates of At and Vt . Therefore, the posterior is essentially the same prior Normal density.

Concerning the auto-regressive coefficients and standard deviations for the structural

shocks, the data seem to be informative about these parameters. Investment-specific shocks

are persistent and more volatile than the neutral technology shocks. The permanent

component of investment-specific shocks is more volatile than the transitory component.

Both types of neutral technology shocks are equally volatile. The permanent component of

the neutral shock is not persistent and the transitory component is very persistent.

The mean value of the parameter η suggests a low depreciation rate in steady state.

It is also worth noticing the relative low value for φ , implying a relatively small cost of

adjustment in investment.

INSERT TABLE 2

4.2. Variance Decomposition

Table 3 summarizes the variance decomposition for each variable used in the

estimation. The variables are the growth rate of real per capita consumption ( g c ), the

growth rate of real per capita investment ( g x ), the growth rate of real per capita GDP ( g y )

and the trade balance to output ratio ( tby ).

The permanent components of both types of shocks are the main source of

consumption growth fluctuations. The permanent neutral shock can account for

approximately 64% of the consumption growth fluctuations.

15
 The contribution of each shock to the investment growth fluctuations is more evenly

spread. Al shocks are important in explaining these fluctuations but investment-specific

shocks can account for more than 60%.

Output growth is driven by transitory neutral and permanent investment-specific

shocks. In fact, the permanent investment-specific shock contributes to more than a half of

the observed variance in output growth.

Finally, the trade balance to GDP ratio is almost entirely driven by the permanent

investment-specific shock with a role for the transitory neutral shock.

In short, the permanent components of neutral and investment-specific shocks are

both important sources of fluctuations in a simple RBC model fitted to Brazilian data.

Furthermore, investment-specific shocks can account for a substantial fraction of

fluctuations in GDP growth, investment growth and trade balance to GDP ratio.

INSERT TABLE 3

4.3. Second Moments

The Bayesian estimation approach uses information in the data to update parameter

values in the model conditional on the cross-equation restriction implied by the equilibrium

conditions. Since the model might not be in line with the data along some dimensions,

sometimes it his hard to match the behavior of individual variables and moments.

Table 4 reports second moments implied by the RBC model. In the model

consumption growth is less volatile than output growth. This counterfactual feature of the

model indicates that consumption smoothing is still important despite the presence of

16
permanent shocks. Investment growth is very volatile due to the very volatile permanent

component of investment-specific shock.

The model is able to generate the positive correlation of consumption and

investment growth with output; though the consumption growth correlation is very low

compared with the data. This is the case since these variables are fundamentally driven by

different sources of fluctuations as shown in table 3.

Consumption and investment growth are weakly auto-correlated. The implied

consumption and investment growth auto-correlations based on the model are compatible

with no auto-correlation. In contrast, the model can replicate accurately the output growth

auto-correlation.

In sum, though the model does not match quantitatively the stylized business cycle

statistics for consumption, investment and output growth, it is able to replicate their

qualitative features and, in some cases, can reproduce the magnitudes of some of the

statistics.

The performance of the model deteriorates concerning the dynamics of the trade

balance. In the model, the trade balance to output ratio is extremely volatile and is not

significantly negatively correlated with consumption, investment and output growth.

Moreover, the degree of auto-correlation is excessive, suggesting the possibility of a unit

root behavior for this variable. These features stand in contrast to the evidence from the

data, pointing to a less volatile and auto-correlated trade balance to output ratio which is

negatively correlated with consumption, investment and output growth.

The behavior of the trade balance to output ratio, in the model fitted to Brazilian

data, have the same characteristics documented in Garcia-Cicco, Pancrazi, and Uribe

(2007) for Argentina. In this last paper, the authors show that the odd behavior of this

17
variable is a feature of the small open economy structure based only on technology shocks

which tend to induce near unit root behavior in consumption that is translated in a near

random walk trade balance to GDP ratio.

INSERT TABLE 4

5. Conclusion

In this paper, I investigate the role of investment-specific technology shocks for

business cycle fluctuations in Brazil. The main goal is to gauge the importance of

investment-specific technology shocks as a source of macroeconomic fluctuations in the

context of the standard Real Business Cycle (RBC) tradition in which fluctuations are

explained by means of technology shocks in an environment without frictions. I estimate

the structural parameters of the RBC model, which includes the autoregressive coefficients

and variances of all types of shocks, by means of Bayesian methods.

There are two main findings. First, variance decompositions show that the

permanent component of both types of technology shock are important sources of business

cycle fluctuations in the context of a standard small open economy RBC model fitted to

Brazilian data. Second, the model cannot replicate second moment statistics, especially

moments involving the trade balance to output ratio. The first result is in line with Aguiar

and Gopinath (2007) and the second result corroborates the findings reported in Garcia-

Cicco, Pancrazi, and Uribe (2007) for Argentina.

In short, empirical evidence from annual Brazilian data shows that the permanent

components of neutral and investment-specific shocks are both important sources of

fluctuations in a simple RBC model. Simulation results concerning the computation of

18
second moments show that a simple RBC model cannot account for stylized facts of

Brazilian business cycles based on a long annual data set.

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Working Paper

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 TABLES

Table 1: Priors

Parameters Density Mean Std. Dev

100(a g − 1) Normal 1.5 1

100(v g − 1) Normal 1.5 1

η Gamma 6.5 3

ρ ag Beta 0.25 0.2

ρ al Beta 0.25 0.2

ρ vg Beta 0.25 0.2

ρ vl Beta 0.25 0.2

φ Gamma 2.5 3

100σ ag Inverted Gamma 2 5

100σ al Inverted Gamma 2 5

100σ vg Inverted Gamma 2 5

100σ vl Inverted Gamma 2 5

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 Table 2: Posteriors

Parameters Mean Std. Dev 90% HPDI

100(a g − 1) 1.5166 1 [-0.1271, 3.1222]

100(v g − 1) 1.5133 1 [-0.0719, 3.1016]

η 11.3288 1.8413 [6.3389, 16.0522]

ρ ag 0.1346 0.0534 [0.0250, 0.2311]

ρ al 0.9172 0.0115 [0.8620, 0.9761]

ρ vg 0.6601 0.0808 [0.4971, 0.8234]

ρ vl 0.5669 0.0905 [0.3549, 0.7740]

φ 2.6163 0.3005 [1.8392, 3.3578]

100σ ag 1.6476 0.3068 [0.5255, 2.6726]

100σ al 1.7288 0.4283 [0.4866, 3.2689]

100σ vg 2.5874 0.4291 [0.5108, 3.6388]

100σ vl 2.0342 0.3849 [0.4303, 5.1311]

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 Table 3: Variance Decomposition (in %)

Variables Shocks

eag eal evg evl

gc 64.0 16.10 19.70 0.20

[55.40, 71.30] [4.50, 28.30] [9.80, 30.60] [0, 0.4]

gx 17.50 20.70 30.70 31.20

[12.70, 21.30] [13.10, 26.90] [9.30, 41.40] [19.20, 44.80]

gy 10.80 33.70 52.60 1.70

[5.20, 17.00] [25.80, 41.70] [41.80, 66.80] [0.40, 4.00]

tby 9.30 16.10 74.70 0.80

[3.40, 14.60] [3.40, 35.40] [48.70, 91.90] [0.10, 1.80]

Results reported are posterior median and 90% HPDI in brackets

24
 Table 4: Second Moments

gc gx gy tby

Standard Deviation (in %)

Data 4.76 10.38 3.59 2.25

Model 3.81 18.52 5.79 41.59

[3.55, 4.07] [15.84, 20.64] [4.18, 7.11] [28.42, 56.39]

Correlation with g y

Data 0.76 0.52 1 -0.27

Model 0.115 0.436 1 0.051

[-0.036, 0.29] [0.293, 0.530] [0.014, 0.098]

Correlation with tby

Data -0.40 -0.18 -0.27 1

Model -0.003 0.271 0.051 1

[-0.079, 0.062] [0.25, 0.294] [0.014, 0.098]

Serial Correlation

Data 0.24 0.19 0.45 0.75

Model 0.017 0.05 0.49 0.988

[0.009, 0.03] [-0.09, 0.15] [0.41 0.58] [0.981, 0.993]

Results reported are posterior median and 90% HPDI in brackets

25
 FIGURES

Figure 1: Equip and machin (in log)

0

-1

-2

-3

-4

-5

-6

-7
10 20 30 40 50 60 70 80 90 00

Figure 2: Relative Price of Investment

1.2

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

-0.6
1970 1975 1980 1985 1990 1995 2000 2005

26