Endogenous borrowing constraints and stagnation in Latin America

Abstract

The Latin American debt crisis of the 1980’s had a major and long-lasting effect on per-capita consumption: its level in 2005 was not that different from that in 1980. This paper studies the long stagnation in per-capita consumption that followed the crisis, and its relationship with recessions and sovereign risk, using a small open economy real business cycle model with complete markets, endogenous borrowing limits (limited commitment), endogenous capital accumulation, and domestic productivity and international interest rate shocks. I find that the model does an excellent job at explaining the observed behavior of per-capita consumption and that both the productivity and international interest rate shocks are important. Furthermore, I show that the participation constraint in this kind of representative agent model can bind not only in good times but also in prolonged bad times.