Alan Finkelstein Shapiro and Federico S. Mandelman
Working Paper 2014-19
November 2014

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We incorporate remittances and microentrepreneurship (self-employment) into a small open-economy business cycle model with capital and labor market frictions. Countercyclical remittances moderate the decline of households' consumption during recessions. These remittances also are used to finance the start-up costs of microenterprises that bolster households' income during economic downturns. However, the positive income effect from countercyclical remittances also leads to a decrease in salaried labor supply, which generates offsetting upward pressure on wages during recessions and adversely affects the recovery of the salaried sector. Therefore, the behavior of remittances decisively affects labor force participation and the composition of employment between nonsalaried and salaried employment over the business cycle. The model delivers labor market and aggregate cyclical dynamics that are consistent with the Mexican data.

JEL classification: E24, E32

Key words: business cycles, search and matching frictions, remittances

The authors gratefully acknowledge Carlos Urrutia for sharing part of the data used in this manuscript. Andrés González Gómez provided valuable comments. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Alan Finkelstein Shapiro, Universidad de los Andes, Department of Economics, Calle 19A No. 1-37 Este, Bloque W, Bogotá, Colombia, a.finkelstein@uniandes.edu.co or Federico S. Mandelman, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street NE Atlanta, GA 30309-4470, 404-498-8785, federico.mandelman@atl.frb.org.