Expropriations and cross-country heterogeneity in consumption volatility

Abstract

The relative volatility of consumption to output decreases with income per capita in the data. A workhorse small open economy real business cycle (RBC) model featuring financial frictions fails to produce this relationship. We can recover the negative relationship when introducing micro-founded expropriations to the RBC model and estimating it using Bayesian methods for over 50 countries. This is because an increase in expropriations reduces investment, freeing up resources for consumption, while moderately lowering output. These effects are amplified in poorer countries, where expropriations are more prevalent. Introducing expropriations can also account for the observed cross-country heterogeneity in consumption-related moments better than the RBC model, including the persistence and co-movement of consumption with output and investment.