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Procyclical International Capital Flows, Debt Overhang And Volatility

  • Patrick-Antoine Pintus


    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579)

In this paper, is show how procyclical capital flows originate boom-bust and sunspot episodes in a neoclassical growth model of a small, open economy. All markets are perfect, with the exception of the fact that some upper, endogenous limit is imposed on how much the economy can borrow from foreign creditors, due to potential debtor default. It is shown that the steady state is locally indeterminate when the credit multiplier is larger than some threshold level, whereas saddle-point stability prevails when the credit multiplier is low enough. As a consequence, high levels of the credit multiplier lead to both booms followed by busts and sunspot-driven volatility near the steady state, while, in contrast, low levels ensure monotonic convergence. Compared with saddle-path equilibria, boom-bust and sunspot equilibria are associated with both lower welfare and debt overhang, that is, a crowding-out effect of credit : when the economy is highly leveraged, it uses savings to cut down foreign debt, at the expense of both human and physical investment. Numerical examples show that volatility arises at rather low values of financial development and for debt-to-GDP ratios that fall within the range of available estimates. Finally, the effects of shocks to the world interest rate on output and consumption are amplified and persistent in the debt overhang regime.

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Paper provided by HAL in its series Working Papers with number halshs-00353596.

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Date of creation: 01 Dec 2007
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Handle: RePEc:hal:wpaper:halshs-00353596
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  1. Philippe Aghion & Abhijit Banerjee & Thomas Piketty, 1999. "Dualism And Macroeconomic Volatility," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1359-1397, November.
  2. Caballe, Jordi & Jarque, Xavier & Michetti, Elisabetta, 2006. "Chaotic dynamics in credit constrained emerging economies," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1261-1275, August.
  3. Daniel Cohen & Jeffrey Sachs, 1985. "Growth and External Debt Under Risk of Debt Repudiation," NBER Working Papers 1703, National Bureau of Economic Research, Inc.
  4. Marta Aloi & Teresa Lloyd-Braga, 2010. "National labor markets, international factor mobility and macroeconomic instability," Economic Theory, Springer, vol. 43(3), pages 431-456, June.
  5. Boyd, John H. & Smith, Bruce D., 1997. "Capital Market Imperfections, International Credit Markets, and Nonconvergence," Journal of Economic Theory, Elsevier, vol. 73(2), pages 335-364, April.
  6. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
  7. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  8. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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