Global Imbalances and Lending Constraints in a Standard Business Cycle Model

Abstract

Does increased international liquidity, the saving glut explain the recent deterioration of US current account balances? In this paper, we develop a simple, two country real business cycle model to answer this question. The salient feature of our model is that lending by one country is constrained by it's wealth by a regulatory or institutional lending constraint. We allow shocks to this lending constraint to capture a country's ability to lend as financial regulations evolve and the country's financial markets to develop. Applying our model to the test case of Japan (lender) and the US, we find that our general equilibrium model captures well, how differential productivity growth affects the flow of capital from the lending country (Japan) to the U.S., and how the lending constraint interacts with productivity growth to impact the borrowing country, or the U.S. current account.