We consider a two country growth model with international capital markets. These markets fund capital investment in both countries, and operate subject to a costly state verification (CSV) problem. Investors in each country require some external finance, but also provide internal finance, which mitigates the CSV problem. When two identical (except for their initial capital stocks) economies are closed, they necessarily converge monotonically to the same steady state output level. Unrestricted international financial trade precludes otherwise identical economies from converging, and poor countries are necessarily net lenders to rich countries. Oscillation in real activity and international capital flows can occur.

Backus, Kehoe and Kydland (1992), Baxter and Crucini (1995) and Stockman and Tesar (1995) find two major discrepancies between standard international business cycle models with complete markets and the data: In the models, cross-country correlations are much higher for consumption than for output, while in the data the opposite is true; and cross-country correlations of employment and investment are negative, while in the data they are positive. This paper introduces a friction into a standard model that helps resolve these anomalies. The friction is that international loans are imperfectly enforceable; any country can renege on its debts and suffer the consequences for future borrowing. To solve for equilibrium in this economy with endogenous incomplete markets, the methods of Marcet and Marimon (1999) are extended. Incorporating the friction helps resolve the anomalies more than does exogenously restricting the assets that can be traded.

In this paper we explain why markets in noncontingent debt securities might be a stable form of market organization for intermediation to households. Efficient-contract allocation might be supported by these markets because households' relationships with their intermediaries do not exactly parallel the explicit form of the noncontingent contracts that they explicitly sign with one another. Also we show that the efficient-contract model can be distinguished from alternative models within the time-series framework that has been widely used to study households' consumption patterns.

Paper prepared for the 'Debt and Credit' Conference at the LSE.

The U.S. Great Recession featured a large decline in output and labor, tighter financial conditions, and a large increase in firm growth dispersion. We build a model in which increased volatility at the firm level generates a downturn and worsened credit conditions. The key idea is that hiring inputs is risky because financial frictions limit firms' ability to insure against shocks. An increase in volatility induces firms to reduce their inputs to reduce such risk. Out model can generate most of the decline in output and labor in the Great Recession and the observed increase in firms' interest rate spreads.

This paper considers four models in which immortal agents face idiosyncratic shocks and trade only a single risk-free asset over time. The four models specify this single asset to be private bonds, public bonds, public money, or private money respectively. I prove that, given an equilibrium in one of these economies, it is possible to pick the exogenous elements in the other three economies so that there is an outcome-equivalent equilibrium in each of them. (The term “exogenous variables” refers to the limits on private issue of money or bonds, or the supplies of publicly issued bonds or money.)