Description:
Empirically, the relative volatility of consumption to output decreases with income. The standard small-open economy real business cycle model, however, produces a positive relationship. We can recover the negative relationship when we augment the standard model with micro-founded expropriations and estimate it using Bayesian methods for almost 60 countries. Introducing expropriations can also account for the observed cross-country heterogeneity in consumption-related moments better than the standard model, including the persistence and co-movement of consumption with output and investment. This is because an increase in expropriations reduces investment, freeing up resources for consumption, while moderately lowering output. These effects are more pronounced in poorer countries, where expropriations tend to be larger