An important body of work has been devoted to understanding both the extent and the causes of the decrease in output volatility in industrialized and middle-income countries since the mid-eighties. In this dissertation, I study the behavior of aggregate output fluctuations in the least developed countries, also referred to as the world’s poorest countries. The basic finding is that the output volatility has moderated. I then survey possible explanations responsible for such moderation.
Chapter 1 establishes two empirical facts on output volatility - structural break and moderation. Looking at the sample of thirty-two countries between 1960 and 2007, I find that there has been a structural break in the volatility of output. Furthermore, examining volatility before and after the break shows that 78% of them experienced moderation during the late eighties.
Chapter 2 answers the question of what might be the possible causes behind this moderation. In particular, I examine two compelling hypotheses that closely relate to these economies - commodity price volatility and trade liberalization. Results on commodity price fluctuations show no supporting evidence for moderation. However, trade liberalization seems to have played an important role. In particular, I look at the effect of openness on output volatility and find the relationship to be negative and significant. This chapter also looks at how trade costs have evolved with an increase in openness (trade/GDP) over the span of fifty years.
Finally, chapter 3 develops a model to determine the impact of trade openness on the aggregate output volatility. In particular, I build a simple two-country, stochastic open-economy business cycle model within a complete market setting. The model incorporates trade costs on the imported good in the home country (poor) to proxy for openness. By varying trade costs, the model is able to explain qualitatively well the changes in the volatility of output.