Capital Flows and Financial Intermediation in a Small Open Economy: Business Cycles with Neoclassical Banks (original) (raw)
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2004
This paper studies the business cycle implications of ∞uctuations in foreign capital in∞ows driven by exogenous world interest-rate changes in a small open economy endowed with a ‘neoclassical’ banking technology. Banks are the only domestic agents with access to international capital markets. They intermediate capital in∞ows by borrowing abroad and lending to domestic flrms and households in a competitive credit market. Whereas flrms demand credit to flnance their working capital, households use credit for consumption smoothing. Calibrating difierent versions of the model to the Argentine economy for the period 1970-1999, quantitative results indicate that a demand for working capital is not enough to break the neutrality of business cycles to interest-rate shocks. Only when banks’ supply of funds is not inflnitely elastic, the model produces a volatility of domestic credit consistent with actual statistics. The standard small open economy RBC model, even when augmented to include ...
Business cycles in a small open economy with a banking sector
2001
This paper studies the interest-rate-driven business cycles of a small open economy (SOE). For than end a costly operated banking system is added to the standard real-business-cycles model. Banks are the only domestic agents considered worthy of credit in international capital markets. They borrow from the rest of the world and lend domestically in a competitive credit market. Existent quantitative models of business cycles in SOE's indicate that interest-rate shocks are unable to cast the kind of output variability produced by productivity or terms-of-trade shocks. Contrary to this finding, it seems that the macroeconomic performances of several SOE's are tightly related to international interest rates and capital flows. Neumeyer and Perri (1999) points out that the introduction of working capital needs may close the gap between the standard model's predictions and the observed consequences of interest-rate shocks. This paper shows that a more careful analysis of the microfoundations of working capital may give rise to an intermediate position where working capital matters in explaining output fluctuations, but not as much as Neumayer and Perri suggest. For that end, the model is calibrated to the Argentinean economy.
World Interest Rate and Business Cycles in Small Open Economies
2005
The consensus about the ability of the standard open-economy neoclassical growth model to account for interest-rate driven business cycles has changed over time: whereas early research concluded that business cycles are neutral to interest-rate shocks, more recent investigations suggest that these shocks can explain a large extent of the business cycles of a small open economy when rms borrow to pay for their labor cost before cashing their sales. The rst goal of this paper is to show that the recently found e¤ectiveness of interest-rate shocks to cause business cycles rests more on the statistical properties of the shocks than on the working-capital constraint; in particular, recent results are only valid when the level and volatility of the interest rate are high and when the interest rate is negatively correlated with total factor productivity. The paper also shows that interest-rate shocks cannot be the sole driving force of business cycles even when the canonical model is aug...
2001
This paper examines a model in which banks engage in valued asset transformation by converting illiquid assets into highly liquid demand deposit accounts that households use for transactions purposes. Premised on banks playing this role in the economy, the paper illustrates how consumption-smoothing behavior can induce countercyclicality in the degree to which rms rely on bank borrowings to nance their working capital expenses. The countercyclical behavior of this degree of bank intermediation" with respect to the nancing of working capital, measured by the volume of commercial and industrial loans in the banking system relative to output, is consistent with the U.S. data. The model further illustrates the importance of accounting for nancial markets that provide alternative sources of short-term funds to rms. Absent these markets, nominal interest rates become nearly perfectly positively correlated with output, which is counterfactual, and monetary shocks (perhaps, arti cially...
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Journal of International Money and Finance, 2011
The purpose of this study is to examine a dynamic, stochastic, general equilibrium framework with financial and informational frictions and foreign borrowing in the case of money growth and technology shocks for a small open economy and to analyze the implications of varying degrees of financial integration for aggregate fluctuations and propagation mechanisms in the economy. The existence of informational asymmetries among the agents in the model necessitates financial intermediation in the economy. Moreover, there is uncertainty involved in the production process which leads to collateralized borrowing by firms and, therefore, has to be taken into account in the design of the loan contracts between firms and financial intermediaries. It is shown that increasing financial integration amplifies the effect of a positive, temporary monetary shock on output, consumption, investment, labor demand and loans; whereas it has barely any implication for the impact of a positive, temporary technology shock on the economy.
Global banking and international business cycles
European Economic Review, 2011
This paper incorporates a global bank into a two-country business cycle model. The bank collects deposits from households and makes loans to entrepreneurs, in both countries. It has to finance a fraction of loans using equity. We investigate how such a bank capital requirement affects the international transmission of productivity and loan default shocks. Three findings emerge. First, the bank's capital requirement has little effect on the international transmission of productivity shocks. Second, the contribution of loan default shocks to business cycle fluctuations is negligible under normal economic conditions. Third, an exceptionally large loan loss originating in one country induces a sizeable and simultaneous decline in economic activity in both countries. This is particularly noteworthy, as the 2007-09 global financial crisis was characterized by large credit losses in the US and a simultaneous sharp output reduction in the US and the Euro Area. Our results thus suggest that global banks may have played an important role in the international transmission of the crisis.
2020
Economic research into the causes of business cycles in small open economies is almost always undertaken using a partial equilibrium model. This approach is characterized by two key assumptions. The first is that the world interest rate is unaffected by economic developments in the small open economy, an exogeneity assumption. The second assumption is that this exogenous interest rate combined with domestic productivity is sufficient to describe equilibrium choices. We demonstrate the failure of the second assumption by contrasting general and partial equilibrium approaches to the study of a crosssection of small open economies. In doing so, we provide a method for modeling small open economies in general equilibrium that is no more technically demanding than the small open economy approach while preserving much of the value of the general equilibrium approach. JEL codes: C55, C68, F41, F44
2021
The procyclical nature of monetary aggregates has been one of the main topics of debate in monetary economics. Most of literature adopts some strategy that involves nominal rigidities or market imperfections in order to explain the causal role that monetary factors play in determining real economic activity. In this thesis I provide a novel explanation to the positive relationship between monetary and real variables in a context of full flexible prices and competitive markets. By adding currency substitution into a standard small open economy RBC model with endogenous money multiplier, the model manages to replicate the positive relationship between monetary aggregates and output in the Argentine economy under different exchange rate regimes. The model also explains the switch in the correlation between the money multiplier and output when exchange rate regime changes. Under a fixed exchange rate regime, the reverse causality mechanism works, and the positive correlation between monetary aggregates and output is driven by the money multiplier. When exchange rate is full flexible, the money multiplier reacts negatively to the productivity shock, and the positive correlation is explained by the currency substitution effect.
International Banks and the Cross-Border Transmission of Business Cycles
SSRN Electronic Journal, 2011
We study the link between the cross-border funding activities of global banks and the international transmission of business cycles. First, using a dataset compiled by the Federal Reserve Board, we document three stylized facts about the operations of foreign banks in the United States: (i) The net borrowing of foreign branches from their parent banks is procyclical with the U.S. economy. (ii) The lending of foreign branches to U.S. …rms is procyclical, and also more volatile than the lending of the domestically chartered banks. (iii) The lending of foreign subsidiaries to small U.S. …rms is procyclical and more volatile than the corresponding lending by U.S. banks, indicating the presence of an extensive margin in foreign banks' lending to U.S. …rms. Second, we build a two-country, dynamic stochastic general equilibrium model to explain these cyclical ‡uctuations in international bank lending and study their macroeconomic implications. In the model, each economy consists of: one representative household that provides bank deposits; two types of banks, "local"and "global", where the latter collects deposits from abroad and issues loans to foreign …rms in addition to its domestic operations; a continuum of monopolistically-competitive …rms that are heterogeneous in labor productivity, and that choose endogenously to borrow working capital from either the local or the global bank. Our model provides a framework to analyze the economic impact of proposed Basel III liquidity regulations.