2. Borrowing Constraints and International Comovements

Abstract

It is now well understood how the presence of borrowing constraints can affect the time series properties of aggregate economic data. In particular the results in Scheinkman and Weiss [9] show that borrowing constraints may cause the appearance of economic fluctuations in an economy where, if the perfect risk sharing implied by a full set of contingent claims markets was available, no aggregate fluctuations would be observed. Departures from perfect risk-sharing across countries would also have several implications for the behavior ofthe international comovements ofeconomic time series. Scheinkman [8] suggested that correlation of consumption series across countries could be used to test for the presence of a full set of contingent claims markets. Also, as it is shown formally below, if the output of different countries are Pareto substitutes in consumption, in a complete markets setting, the correlation of output series should be smaller (algebraically) than that of the corresponding productivity series. In this paper we construct a formal model of a two country economy that allows us to derive implications of the presence of borrowing constraints on the behavior of economic time series. Simulations of the model reveal that it is capable of generating significant positive correlation across output series even in the presence of uncorrelated productivity shocks. This result suggests that borrowing constraints can be used to explain the substantial positive correlation of output growth across countries in the presence of almost no correlation of productivity growth series (cf. Costello [5]). Further the model can generate a much lower consumption correlation than