Do institutions matter for economic fluctuations? Weak property rights in a business cycle model for Mexico

This paper shows that the dependence of the standard real business cycle (RBC) model on unobservable technology shocks can be reduced once we allow for weak property rights. This is motivated by the empirical observation that changes in institutions in emerging markets are related to the evolution of the main macroeconomic variables. We thus incorporate weak property rights in the baseline RBC model and use the ICRG dataset to obtain a proxy for the persistence and standard deviation of the degree of protection of property rights in Mexico. We find that this model does not need to rely on unobservable technology shocks, as innovations to the degree of protection of property rights only (i.e. without a technology shock) can predict the second moments of the main economic variables quite well.