The Macroeconomic Consequences of Remittances

This study examines the impact of a remittances shock on the main macroeconomic aggregates of a small open economy. It uses a stochastic limited participation model to generate dynamics that are consistent with the empirical literature, like the increase in inflation, consumption, and leisure. However, the remittances shock generates a prolonged decline in GDP, which only diminishes when remittances are a larger percentage of GDP, the fraction of remittances directed towards investment increases, or when the fraction of labor income that remittances represent is reduced and is overturned when the persistence of the remittances shocks is shortened. 1. Introduction Remittances have been on the rise for the last several decades. International estimates of official remittance flows suggest that the total amount of remittances received by developing countries has surpassed 300 billion US dollars in 2011, from which almost 61 billion went to Latin America and the Caribbean (Inter-American Development Bank [1]). Their importance does not only come from their size, but also from their relative importance as a share of GDP in some countries and from their increasing share in all financial flows entering developing countries. They now represent approximately 45 percent of net capital inflows in these countries. The significant increase in remittances is attributed to the rapid growth of money transfer institutions, to the decreases in the average transaction cost of remitting, and also to a renewed surge in migration flows before the financial crisis. Most of the existing literature on remittances concentrates on the microeconomic implication of such flows, for the sender or the receiver of these funds. Based on survey data, this strand of the literature has examined the motivation to remit—contractual arrangements, altruism, repayment of migration costs, and so forth—and the uses of these funds in the home country—for education, health care, entrepreneurial initiatives, social works, and so forth. However, despite the limitations in terms of data quality at the aggregate level, the increasing importance of remittances has led many researchers and policymakers to turn their attention to the potential impact that these financial flows can have on macroeconomic aggregates. While recent research has shed some light on their potential influence on consumption and inflation (Narayan et al. [2] and Vacaflores [3]), on the exchange rate and trade competitiveness (Amuedo-Dorantes and Pozo [4] and Acosta et al. [5]), on labor supply (Funkhouser [6], Hanson [7], Chami et