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Financial Integration, Excess Consumption Volatility, and the World Real Interest Rate

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  • YAMADA, Haruna

Abstract

Contrary to classical macroeconomic theory, the volatility of consumption relative to income has risen in emerging markets despite the international financial integration. This study presents a theoretical mechanism of this phenomenon by developing a small open economy model with an occasionally binding borrowing constraint, named the Interest Coverage Ratio-based borrowing constraint. Calibration exercises show that financial integration improves consumption smoothing and mitigates income shocks. Meanwhile, the foreign debt limit is more sensitive to changes in the world real interest rate. An increase in the world real interest rate tightens the borrowing constraint and decreases consumption significantly for the repayment. Financial integration would make consumption more vulnerable to the world real interest rate changes, resulting the higher volatility in emerging markets.

Suggested Citation

  • YAMADA, Haruna, 2023. "Financial Integration, Excess Consumption Volatility, and the World Real Interest Rate," Discussion paper series HIAS-E-133, Hitotsubashi Institute for Advanced Study, Hitotsubashi University.
    • Handle: RePEc:hit:hiasdp:hias-e-133
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    References listed on IDEAS

    as
    1. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, vol. 115(1), pages 69-102.
    2. Blankenau, William & Ayhan Kose, M. & Yi, Kei-Mu, 2001. "Can world real interest rates explain business cycles in a small open economy?," Journal of Economic Dynamics and Control, Elsevier, vol. 25(6-7), pages 867-889, June.
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    More about this item

    Keywords

    Financial Integration; Excess Consumption Volatility; Emerging Market Economy; World Real Interest Rate; Occasionally Binding Borrowing Constraint;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F62 - International Economics - - Economic Impacts of Globalization - - - Macroeconomic Impacts

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