We incorporate remittances and microentrepreneurship (self-employment) into a small openeconomy 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.
business cycles search and matching frictions remittances