An Empirical Study of Taiwan’s Real Business Cycle

We study the characteristics of the real business cycle and the sources of the economic fluctuation in Taiwan over the last forty years, when it experienced both developing and developed stages of the economy, by considering a small open economy real business cycle model with financial friction. In particular, the breaking time point that distinguishes between developing and developed stages of the economy in Taiwan is chosen on the basis of the International Monetary Fund (IMF). We use a Bayesian approach to obtain the posterior densities for the structural parameters of interest. Conditioning on the Bayesian point estimates, the posterior mean in particular, we generate a set of statistical moments and related statistics that characterize the features and sources of the real business cycle. We find that a real business cycle model with financial friction explains the features of real business cycle in a developing stage of Taiwan’s economy well. However, the results it provides are unsatisfactory for matching the characteristics of real business cycle in a developed stage of Taiwan’s economy. In addition, the technology shock explains a large fraction of the economic fluctuation, particularly in real output, consumption and investment. More precisely, permanent technology shock explains a larger fraction of the economic fluctuation than a transitory technology shock.