Collateral Constraints and Macroeconomic Adjustment in an Open Economy

This paper analyzes a small open economy Ramsey growth model with convex investment costs and a collateral constraint on borrowing. Optimal control methods are used to characterize the dynamics of investment, consumption, and debt. The analysis demonstrates that the economy’s adjustment speed depends on the fraction of the capital stock that can be used as collateral. In the presence of non-convexities, a higher loan-to-value of the capital stock may produce a bifurcation in the dynamics by increasing the economy’s adjustment speed. In contrast to the canonical small open economy model with convex investment costs, domestic and foreign savings are growth-rate complements due to the interaction between domestic savings, the price of capital, and the borrowing constraint. The standard closed economy Ramsey model, the Cohen-Sachs debt repudiation model, and the canonical small open economy model with adjustment costs are shown to be special cases of the analysis.