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Financial integration, credit market imperfections and consumption smoothing

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  • Leblebicioglu, AslI

Abstract

Contrary to standard theoretical reasoning, recent empirical research shows that financial integration is associated with higher consumption volatility in developing countries. This paper illustrates how domestic credit market imperfections can alter the standard predictions about the consumption smoothing possibilities under financial autarky and international financial integration. I use a two-country international real business cycle model where the non-traded sector in the small country faces borrowing constraints due to contract enforceability problems. If the international risk-sharing opportunities are non-existent, households can secure themselves against the shocks in the non-traded sector only by adjusting their labor effort, which leads to changes in sectorial output and terms of trade. The deterioration of the terms of trade acts as a dampening effect on consumption, causing it to be less volatile under financial autarky relative to financial integration. Under financial integration, international financial assets provide the insurance against domestic productivity shocks without affecting the relative prices, hence allowing the consumption to react more.

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  • Leblebicioglu, AslI, 2009. "Financial integration, credit market imperfections and consumption smoothing," Journal of Economic Dynamics and Control, Elsevier, vol. 33(2), pages 377-393, February.
  • Handle: RePEc:eee:dyncon:v:33:y:2009:i:2:p:377-393
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    Cited by:

    1. Rudrani Bhattacharya & Ila Patnaik, 2016. "Financial Inclusion, Productivity Shocks, and Consumption Volatility in Emerging Economies," World Bank Economic Review, World Bank Group, vol. 30(1), pages 171-201.
    2. Kose, M. Ayhan & Prasad, Eswar & Rogoff, Kenneth & Wei, Shang-Jin, 2010. "Financial Globalization and Economic Policies," Handbook of Development Economics, Elsevier.
    3. Agénor, Pierre-Richard & Alper, Koray & Pereira da Silva, Luiz A., 2014. "Sudden floods, macroprudential regulation and stability in an open economy," Journal of International Money and Finance, Elsevier, vol. 48(PA), pages 68-100.
    4. M Ayhan Kose & Eswar Prasad & Kenneth Rogoff & Shang-Jin Wei, 2009. "Financial Globalization: A Reappraisal," IMF Staff Papers, Palgrave Macmillan, vol. 56(1), pages 8-62, April.
    5. Rudrani Bhattacharya & Ila Patnaik, 2013. "Credit Constraints, Productivity Shocks and Consumption Volatility in Emerging Economies," IMF Working Papers 13/120, International Monetary Fund.
    6. Quy-Toan Do & Andrei A. Levchenko & Martin Ravallion, 2014. "Trade Insulation as Social Protection," NBER Chapters,in: The Economics of Food Price Volatility, pages 345-366 National Bureau of Economic Research, Inc.
    7. Pierre-Richard Agénor, 2015. "L’intégration financière internationale : Théories, évidences, et leçons des expériences récentes [International financial integration: Theory, evidence and lessons from recent experiences]," Research papers & Policy papers 1508, OCP Policy Center.
    8. Martin D. Evans & Viktoria V. Hnatkovska, 2007. "Financial Integration, Macroeconomic Volatility, and Welfare," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 500-508, 04-05.
    9. Guillermo Larrain & Mariel Siravegna & Guillermo Yañez, 2009. "Intégration aux marchés financiers internationaux et lissage de la consommation : observations récentes en Amérique latine," Revue d'Économie Financière, Programme National Persée, vol. 95(2), pages 87-108.
    10. Pierre-Richard Agénor & K. Alper & L. Pereira da Silva, 2012. "Sudden Floods, Prudential Regulation and Stability in an Open Economy," Working Papers Series 267, Central Bank of Brazil, Research Department.
    11. Bhattacharya, Rudrani & Patnaik, Ila, 2013. "Credit constraints, productivity shocks and consumption volatility in emerging economies," Working Papers 13/121, National Institute of Public Finance and Policy.

    More about this item

    Keywords

    Financial integration Consumption smoothing Credit market frictions Emerging markets RBC models;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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