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Revisiting Overborrowing and Its Policy Implications

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  • Gianluca Benigno
  • Huigang Chen
  • Chris Otrok
  • Alessandro Rebucci
  • Eric Young

Abstract

This paper analyzes quantitatively the extent to which there is overborrowing (i.e., inefficient borrowing) in a business cycle model for emerging market economies with production and an occasionally binding credit constraint. The main finding of the analysis is that overborrowing is not a robust feature of this class of model economies: it depends on the structure of the economy and its parametrization. Specifically, we find underborrowing in a production economy with our baseline calibration, but overborrowing with more impatient agents and more volatile shocks. Endowment economies display overborrowing regardless of parameter values, but they do not allow for policy intervention when the constraint binds (in crisis times). Quantitatively, the welfare gains from implementing the constrained-efficient allocation are always larger near crisis times than in normal ones. In production economies, they are one order of magnitude larger than in endowment economies both i n crisis and normal times. This suggests that the scope for economy-wide macro-prudential policy interventions (e.g. prudential taxation of capital flows and capital controls) is weak in this class of models.

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Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1020.

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Date of creation: Oct 2010
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Handle: RePEc:cep:cepdps:dp1020

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: Bailouts; financial frictions; macro prudential policies; overborrowing;

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  1. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  2. Richard Arnott & Bruce Greenwald & Joseph E. Stiglitz, 1993. "Information and Economic Efficiency," NBER Working Papers 4533, National Bureau of Economic Research, Inc.
  3. Timothy J. Kehoe & Kim J. Ruhl, 2008. "Are Shocks to the Terms of Trade Shocks to Productivity?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 804-819, October.
  4. Kumar, Praveen & Seppi, Duane J, 1994. "Information and Index Arbitrage," The Journal of Business, University of Chicago Press, vol. 67(4), pages 481-509, October.
  5. Javier Bianchi, 2011. "Overborrowing and Systemic Externalities in the Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 101(7), pages 3400-3426, December.
  6. Ricardo J Caballero, 2010. "Sudden Financial Arrest," IMF Economic Review, Palgrave Macmillan, Palgrave Macmillan, vol. 58(1), pages 6-36, August.
  7. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, Springer, vol. 6(4), pages 459-472, November.
  8. John Moore & Nobuhiro Kiyotaki, . "Credit Cycles," Discussion Papers, Edinburgh School of Economics, University of Edinburgh 1995-5, Edinburgh School of Economics, University of Edinburgh.
  9. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, American Economic Association, vol. 78(3), pages 402-17, June.
  10. Jonathan D. Ostry & Carmen M. Reinhart, 1992. "Private Saving and Terms of Trade Shocks: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 495-517, September.
  11. Jonathan David Ostry & Atish R. Ghosh & Karl Friedrich Habermeier & Marcos Chamon & Mahvash Saeed Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows," IMF Staff Position Notes 2010/04, International Monetary Fund.
  12. Nikolov, Kalin, 2010. "Is Private Leverage Excessive?," MPRA Paper 28407, University Library of Munich, Germany, revised Jun 2010.
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