Ebook Domestic and Foreign Lenders and International Business Cycles
The importance of credit market imperfections in explaining business fluctuations has been the object of analysis of a large literature in the last two decades. More recently, a number of studies have analyzed open economy models with financial frictions, finding that these models can go in the right direction in explaining the international transmission of business cycles (e.g. Kehoe and Perri, 2002, Baxter and Crucini, 1995, and the papers cited below). One shortcoming of these studies is that they are silent on the different importance that credit imperfections can have according to the nature domestic and foreign of lenders.
Since credit imperfections are thought to stem from lack of information of lenders on borrowers, it appears reasonable that these imperfections differ according to the origin of the lenders. In fact, foreign lenders are likely to have limited experience of local firms and laws, presumably because of a short history in lending to local firms. More importantly, once we tie credit imperfections to the nature of the lenders, it is plausible that the relative importance of foreign versus domestic imperfections changes over the cycle. In fact, the absolute importance of credit imperfections depends on aggregate variables; and a change in aggregate variables is unlikely to leave unaffected the relative importance of credit imperfections.
In this paper we show how changes in the importance of foreign versus domestic credit imperfections and the resulting effects in the decision of domestic firms as to which lenders to choose (domestic or foreign) can explain important aspects of the international transmission of business cycles. In particular, we focus on the comovement of output across countries. In the data, for instance, it is generally observed that following a positive shock to the productivity of a country, output in the country hit by the shock and abroad rise. Standard open economy RBC models (see e.g. Backus, Kehoe and Kydland, 1992) cannot replicate this pattern of the data: these models predict that when country F (foreign) is hit by a positive technology shock, output in country H (home) falls, especially as a result of a shift of resources towards the most productive economy.
We consider a two-country open economy model. In our model economy, entrepreneurs in both countries face restrictions in borrowing from domestic and foreign financiers, as in Gilchrist, Hairault and Kempf (2002) and Faia (2002). To this story, we add two new dimensions: (i) the relative importance of the credit frictions that entrepreneurs face in borrowing from domestic or foreign lenders changes endogenously over the cycle and (ii) entrepreneurs can adjust their relative debt exposure in order to maximize their borrowing capacity. In our model economy, entrepreneurs face a quantity borrowing constraint à-la Kiyotaki and Moore (1997), i.e. they cannot borrow more than the value of the hard assets (i.e., real estate) they can pledge as collateral. Lenders, on the other hand, face a transaction cost in liquidating the collateral of borrowers.
This transaction cost can proxy for a cost in recovering collateral during bankruptcy procedures or in redeploying assets in the secondary market at the liquidation stage. The presence of this transaction cost prevents entrepreneurs from borrowing up to the full value of their hard assets. Crucially, the liquidation technologies of domestic and foreign lenders differ. Domestic lenders face a transaction cost that is proportional to the collateral value. Foreign lenders face diseconomies to scale in recovering and/or liquidating collateral: the fraction of collateral value they lose in liquidation increases as the collateral value increases. By assuming diseconomies to scale in their liquidation technology, we aim at capturing the idea that foreign lenders have probably less experience than domestic lenders in recovering borrowers’ assets and less knowledge of their best alternative uses.
Experience and knowledge, in other words, might represent a scarce local input such that, the higher is the value of the assets that foreign lenders recover and redeploy, the more their limited “liquidation ability” becomes strained. In the paper, we elaborate on this feature of the model offering examples, providing empirical evidence and discussing related assumptions in the literature.
Download
PDF Ebook Domestic and Foreign Lenders and International Business Cycles
Posted in :
