persistence of macroeconomic aggregates, measured by the first order autocorrelation. To compute statistics, all variables, except GDP ratios, are expressed in per capita terms and logged and then, all are filtered using the Hodrick-Prescott filter with the smoothing parameter set at 100, the value commonly used for annual data. Statistics for the simulated economies are the means of statistics computed for each of 200 replications. Each simulation is 228 periods long and the first 200 observations are dropped so that the results do not depend on initial conditions. Second moments are computed using the remaining 28 observations - equal to the average sample size of 28 yearly periods of the database used to compute Latin America’s business cycle facts.

In general, the benchmark model economy matches the core of business cycle frequency properties for the typical LAC economy. The ability of the benchmark model economy to mimic key qualitative aspects related to persistence and comovements in actual cyclical behavior is remarkable. The model correctly predicts that disposable income, consumption and investment are strongly procyclical while the trade balance to output ratio as well as the government debt to output ratio behave countercyclically. Even from a quantitative point of view, the model is quite successful in replicating some of these cyclical correlations. The model also accounts for the strong persistence observed in most macroeconomic aggregates.

The model matches the relative volatility of disposable income but does not quite succeed in reproducing the volatility of consumption and tax revenue.<sup>10</sup> However, the inability to mimic these features cannot be considered a major failure of the model. The volatility of consumption is overestimated in the data because it includes durable goods consumption which tends to behave more like investment and, therefore, to exhibit much higher volatility. Tax revenue volatility is understated because the model does not allow for tax disturbances. WoldeMariam and Stotsky (2002) report significant changes in the region’s tax systems over the last two decades. As a result, the inclusion of stochastic tax changes may not only increase the predicted volatility of tax revenue but also that of consumption. This avenue is not pursued here because the primary objective of the paper is to evaluate the automatic stabilization role of a given tax structure.

Interestingly, the model economy inhabited exclusively by Ricardian households yields very similar unconditional second moments. There is only one important difference to underscore. When the fraction of low-wealth households is 0.60 (π = 0.60) , the (benchmark) model economy counterfactually predicts that tax revenues are countercyclical. Instead, the Ricardian economy (π = 0) displays a significantly larger procyclicality of tax proceeds, roughly in line with observed behavior in the region. As shown below, the volatility levels predicted by the two economies are quite different and conditioned by both the tax structure and the source of fluctuations.

As in the data, the model correctly predicts a high positive correlation between government spending and output. This prediction remains unchanged when using the first difference filter instead of the Hodrick-Prescott filter to detrend simulated government

> 10 kx The capital adjustment cost parameter ψ is calibrated so as to match the volatility of investment generated by the model to that of aggregate investment in the data.

23