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External Shocks and Debt Accumulation in a Small Open Economy

Author

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  • Abdelhak S. Senhadji

    (International Monetary Fund)

Abstract

This paper analyzes the borrowing behavior of a small open economy of a Less Developed Country (LDC) that relies heavily on imports for its capital formation and faces an upward sloping supply function of foreign loans, in an environment where decision makers face uncertainty about the longevity of external shocks. First, a dynamic general equilibrium model is developed which replicates fairly well the business cycle properties of the LDC data. Second, it is shown that uncertainty concerning the longevity of shocks (a relevant type of uncertainty, especially for LDCs) generates forecast errors that are autocorrelated in a way that is similar to Bayesian learning in the "peso problem." This autocorrelated forecast errors can generate substantial debt accumulation. Third, it is shown that the assumption of an upward sloping supply function of foreign loans, which is a more realistic assumption for LDCs than the usual perfectly elastic one, offers an alternative to the Uzawa-type utility function for the analysis of asset accumulation in the small open economy framework. (Copyright: Elsevier)

Suggested Citation

  • Abdelhak S. Senhadji, 2003. "External Shocks and Debt Accumulation in a Small Open Economy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(1), pages 207-239, January.
    • Handle: RePEc:red:issued:v:6:y:2003:i:1:p:207-239
    DOI: 10.1016/S1094-2025(02)00015-7
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    References listed on IDEAS

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    More about this item

    Keywords

    Debt accumulation; Stochastic dynamic general equilibrium model; External shocks; Incomplete information; Less Developed Economies;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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