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International Credit Flows and Pecuniary Externalities

Author(s): Brunnermeier, Markus K; Sannikov, Yuliy

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Abstract: This paper develops a dynamic two-country neoclassical stochastic growth model with incomplete markets. Short-term credit flows can be excessive and reverse suddenly. The equilibrium outcome is constrained inefficient due to pecuniary externalities. First, an undercapitalized country borrows too much since each firm does not internalize that an increase in production capacity undermines their output price, worsening their terms of trade. From an ex ante perspective each firm undermines the natural “terms of trade hedge.” Second, sudden stops and fire sales lead to sharp price drops of illiquid capital. Capital controls or domestic macro-prudential measures that limit short-term borrowing can improve welfare.
Publication Date: Jan-2015
Citation: Brunnermeier, Markus K, Sannikov, Yuliy. (2015). International Credit Flows and Pecuniary Externalities. American Economic Journal: Macroeconomics, 7 (1), 297 - 338. doi:10.1257/mac.20140054
DOI: doi:10.1257/mac.20140054
ISSN: 1945-7707
EISSN: 1945-7715
Pages: 297 - 338
Type of Material: Journal Article
Journal/Proceeding Title: American Economic Journal: Macroeconomics
Version: Final published version. Article is made available in OAR by the publisher's permission or policy.

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