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International Business Cycles with Endogenous Incomplete Markets

  • Patrick J. Kehoe

    ()

    (Federal Reserve Bank of Minneapolis, U.S.A. and University of Minnesota, U.S.A.; and NBER)

  • Fabrizio Perri

    ()

    (New York University, U.S.A. and Princeton University, U.S.A. and CEPR)

Backus, Kehoe, and Kydland (1992), Baxter and Crucini (1995), and Stockman and Tesar (1995) find two major discrepancies between standard international business cycle models with complete markets and the data: In the models, cross-country correlations are much higher for consumption than for output, while in the data the opposite is true; and cross-country correlations of employment and investment are negative, while in the data they are positive. This paper introduces a friction into a standard model that helps resolve these anomalies. The friction is that international loans are imperfectly enforceable; any country can renege on its debts and suffer the consequences for future borrowing. To solve for equilibrium in this economy with endogenous incomplete markets, the methods of Marcet and Marimon (1999) are extended. Incorporating the friction helps resolve the anomalies more than does exogenously restricting the assets that can be traded. Copyright The Econometric Society 2002.

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Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 70 (2002)
Issue (Month): 3 (May)
Pages: 907-928

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Handle: RePEc:ecm:emetrp:v:70:y:2002:i:3:p:907-928
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