Foreign borrowing and macroeconomic adjustment to external shocks

Abstract

This paper analyzes the impact of anticipated and unanticipated external shocks on the evolution of macroeconomic variables, particularly foreign borrowing, and on steady-state stocks of capital and debt. We find that the desired mode of adjustment to a shock is highly sensitive to its nature. Intertemporal substitution effects often dominate the pure wealth loss effect. External disturbances will typically be intertemporally correlated in the real world; the paper analyses the resulting implications for the dynamic smoothing of adjustment.