External Imbalances and Collateral Constraints in a Two-Country World

Mardi | 2009-02-24


In this article, we focus on current account dynamics in large openeconomies characterized by debt-constrained heterogeneous agents andendogenous monetary policies. We incorporate three key features thathave bulked large in the New Open Macroeconomics literature: i) homebias in trade ii) price rigidities and iii) durable goods (real properties).In order to limit agents’ willingness to consume and to (partially) insurecreditors against the risk of default, we incorporate collateral constraints.We show that the impatience of collateral-constrained agents can be at theroots of permanent external imbalances; indeed our model has a uniqueand dynamically determinate steady state, which is characterized by apositive level of debt. Our framework allows us to analyze the linkagebetween exchange rates, real assets and international capital flows. Wefocus on this mechanism so as to track the (international) transmissionof shocks and the implications for the monetary policy; we show howdevelopments affecting the house market can affect current account andexchange rate dynamics.