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International Credit Flows and Pecuniary Externalities

Author

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  • Markus K. Brunnermeier
  • Yuliy Sannikov

Abstract

This paper develops a dynamic two-country neoclassical stochastic growth model with incomplete markets. Short-term credit flows can be excessive and reverse suddenly. The equilibrium outcome is constrained inefficient due to pecuniary externalities. First, an undercapitalized country borrows too much since each firm does not internalize that an increase in production capacity undermines their output price, worsening their terms of trade. From an ex ante perspective each firm undermines the natural "terms of trade hedge". Second, sudden stops and fire sales lead to sharp price drops of illiquid capital. Capital controls or domestic macro-prudential measures that limit short-term borrowing can improve welfare. (JEL F32, F43, G15, O41)

Suggested Citation

  • Markus K. Brunnermeier & Yuliy Sannikov, 2015. "International Credit Flows and Pecuniary Externalities," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 297-338, January.
  • Handle: RePEc:aea:aejmac:v:7:y:2015:i:1:p:297-338
    Note: DOI: 10.1257/mac.20140054
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    More about this item

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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