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Leverage constraints and real interest rates

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  • Isohätälä, Jukka
  • Kusmartsev, Feo
  • Milne, Alistair
  • Robertson, Donald

Abstract

This paper investigates the macroconomics of real interest rates when there are constraints on debt finance, used both for insurance against income shocks and transferability of resources over time. We amend a standard continuous-time deterministic model of international exchange, with patient and impatient countries, introducing country level shocks fully diversifiable at the global level. A series of shocks that push one country towards its leverage limit induces substantial pre-cautionary saving and a collapse of real interest rate relative to the deterministic benchmark. We discuss the resulting dynamics of interest rates and the broader implications for macroeconomic modelling.

Suggested Citation

  • Isohätälä, Jukka & Kusmartsev, Feo & Milne, Alistair & Robertson, Donald, 2014. "Leverage constraints and real interest rates," Bank of Finland Research Discussion Papers 27/2014, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2014_027
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    More about this item

    Keywords

    borrowing constraints; debt management; incomplete financial markets; international macroeconomics; finance and macroeconomics; macroeconomic propagation; precautionary saving; systemic risk;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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