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Procyclical International Capital Flows, Debt Overhang And Volatility

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  • Patrick-Antoine Pintus

    ()
    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579)

Abstract

In this paper, is show how procyclical capital flows originate boom-bust and sunspot episodes in a neoclassical growth model of a small, open economy. All markets are perfect, with the exception of the fact that some upper, endogenous limit is imposed on how much the economy can borrow from foreign creditors, due to potential debtor default. It is shown that the steady state is locally indeterminate when the credit multiplier is larger than some threshold level, whereas saddle-point stability prevails when the credit multiplier is low enough. As a consequence, high levels of the credit multiplier lead to both booms followed by busts and sunspot-driven volatility near the steady state, while, in contrast, low levels ensure monotonic convergence. Compared with saddle-path equilibria, boom-bust and sunspot equilibria are associated with both lower welfare and debt overhang, that is, a crowding-out effect of credit : when the economy is highly leveraged, it uses savings to cut down foreign debt, at the expense of both human and physical investment. Numerical examples show that volatility arises at rather low values of financial development and for debt-to-GDP ratios that fall within the range of available estimates. Finally, the effects of shocks to the world interest rate on output and consumption are amplified and persistent in the debt overhang regime.

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Bibliographic Info

Paper provided by HAL in its series Working Papers with number halshs-00353596.

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Date of creation: 01 Dec 2007
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Handle: RePEc:hal:wpaper:halshs-00353596

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Related research

Keywords: international financial markets; endogenous borrowing constraints; small open economy; debt overhang; business cycles; indeterminacy; sunspot equilibria;

References

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  1. Piketty, Thomas & Banerjee, Abhijit & Aghion, Philippe, 1997. "Dualism and macroeconomic volatility," CEPREMAP Working Papers (Couverture Orange) 9720, CEPREMAP.
  2. Cohen, Daniel & Sachs, Jeffrey, 1986. "Growth and external debt under risk of debt repudiation," European Economic Review, Elsevier, vol. 30(3), pages 529-560, June.
  3. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
  4. Marta Aloi & Teresa Lloyd-Braga, . "National Labor Markets, International Factor Mobility and Macroeconomic Instability," Discussion Papers 09/10, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  5. Jordi Caballe & Xavier Jarque & Elisabetta Michetti, 2004. "Chaotic Dynamics in Credit Constrained Emerging Economies," UFAE and IAE Working Papers 605.04, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  6. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  7. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  8. Boyd, John H. & Smith, Bruce D., 1997. "Capital Market Imperfections, International Credit Markets, and Nonconvergence," Journal of Economic Theory, Elsevier, vol. 73(2), pages 335-364, April.
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Cited by:
  1. Silvio Contessi & Pierangelo De Pace & Johanna Francis, 2009. "The Cyclical Properties of Disaggregated Capital Flows," Fordham Economics Discussion Paper Series dp2009-05, Fordham University, Department of Economics.
  2. Kunieda, Takuma, 2008. "Finance and Growth Cycles," MPRA Paper 11340, University Library of Munich, Germany.

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