Real business cycles in small emerging economies : the role of financial frictions and dollarization

The objective of this thesis is to explain and empirically evaluate real business cycle (RBC) models in small and emerging economies. The focus of the thesis is to explore the role of financial sector in propagation and amplification of real business cycle in these economies. This objective is achieved through self-contained chapters (chapter 2-6) where one or more forms of financial features of interest are incorporated. The thesis makes theoretical and empirical contribution to real business cycle literature on small and emerging economies through methodological innovation used to incorporate financial features and empirical estimation of the models using Bayesian framework. The theoretical and empirical work is direct at establishment of real business cycle properties and processes of the Maldives. As of my knowledge, there are no empirical studies done to document and explain business cycle in the Maldives. One of the reasons for lack of studies are due to scarcity of relevant data. A small but growing literature is emerging in relation to exchange rate regime and the effect of exchange rate on domestic prices. However, to fully understand the impact of exchange rate in a dollarized economy like the Maldives, an appropriate general equilibrium framework with exchange rate is needed. This thesis therefore contributes to such a framework. Furthermore, using Chapter 3, I have addressed the gap in data availability and quality by comparing a database developed using archives with the secondary sources. The literature studying role of financial friction and dollarization in the propagation and amplification of business cycle through RBC framework is a growing area. Empirical work incorporating liability dollarization using RBC framework is scarce. The overall result from thesis is summarised as follows: Maldivian business cycle follows the predictions from the literature; dollarization, real exchange rate and risk premium are the main drivers of business cycles.