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Revisiting Overborrowing and Its Policy Implications

  • Gianluca Benigno
  • Huigang Chen
  • Chris Otrok
  • Alessandro Rebucci
  • Eric Young

This paper analyzes quantitatively the extent to which there is overborrowing (i.e., inefficient borrowing) in a business cycle model for emerging market economies with production and an occasionally binding credit constraint. The main finding of the analysis is that overborrowing is not a robust feature of this class of model economies: it depends on the structure of the economy and its parametrization. Specifically, we find underborrowing in a production economy with our baseline calibration, but overborrowing with more impatient agents and more volatile shocks. Endowment economies display overborrowing regardless of parameter values, but they do not allow for policy intervention when the constraint binds (in crisis times). Quantitatively, the welfare gains from implementing the constrained-efficient allocation are always larger near crisis times than in normal ones. In production economies, they are one order of magnitude larger than in endowment economies both i n crisis and normal times. This suggests that the scope for economy-wide macro-prudential policy interventions (e.g. prudential taxation of capital flows and capital controls) is weak in this class of models.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1020.

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Date of creation: Oct 2010
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Handle: RePEc:cep:cepdps:dp1020
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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  1. Paul Krugman, 1999. "Balance Sheets, the Transfer Problem, and Financial Crises," International Tax and Public Finance, Springer, vol. 6(4), pages 459-472, November.
  2. Timothy J. Kehoe & Kim J. Ruhl, 2007. "Are shocks to the terms of trade shocks to productivity?," Staff Report 391, Federal Reserve Bank of Minneapolis.
  3. Javier Bianchi, 2009. "Overborrowing and systemic externalities in the business cycle," FRB Atlanta Working Paper 2009-24, Federal Reserve Bank of Atlanta.
  4. Ricardo J Caballero, 2010. "Sudden Financial Arrest," IMF Economic Review, Palgrave Macmillan, vol. 58(1), pages 6-36, August.
  5. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
  6. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  7. Jonathan D. Ostry & Carmen M. Reinhart, 1992. "Private Saving and Terms of Trade Shocks: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 495-517, September.
  8. Arnott, Richard & Greenwald, Bruce & Stiglitz, Joseph E., 1994. "Information and economic efficiency," Information Economics and Policy, Elsevier, vol. 6(1), pages 77-82, March.
  9. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2010. "Financial Crises and Macro-Prudential Policies," CEP Discussion Papers dp1032, Centre for Economic Performance, LSE.
  10. repec:idb:wpaper:369 is not listed on IDEAS
  11. Timothy J. Kehoe & Kim Ruhl, 2008. "Data Appendix to "Are Shocks to the Terms of Trade Shocks to Productivity?"," Technical Appendices 07-40, Review of Economic Dynamics.
  12. Kumar, Praveen & Seppi, Duane J, 1994. "Information and Index Arbitrage," The Journal of Business, University of Chicago Press, vol. 67(4), pages 481-509, October.
  13. Nikolov, Kalin, 2010. "Is Private Leverage Excessive?," MPRA Paper 28407, University Library of Munich, Germany, revised Jun 2010.
  14. Jonathan David Ostry & Atish R. Ghosh & Karl F Habermeier & Marcos d Chamon & Mahvash S Qureshi & Dennis B. S. Reinhardt, 2010. "Capital Inflows; The Role of Controls," IMF Staff Position Notes 2010/04, International Monetary Fund.
  15. Greenwood, Jeremy & Hercowitz, Zvi & Huffman, Gregory W, 1988. "Investment, Capacity Utilization, and the Real Business Cycle," American Economic Review, American Economic Association, vol. 78(3), pages 402-17, June.
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