Across developing countries, capital market inefficiencies tend to decrease and external borrowing tends to sharply increase as national wealth rises. We construct a simple model of intertemporal trade under asymmetric information which provides a coherent explanation of both these phenomenon, without appealing to imperfect capital mobility. The model can be applied to a number of policy issues in LDC lending, including the debt overhang problem, and the impact of government guarantees of private debt to foreign creditors. In the two-country general equilibrium version of the model, an increase in wealth in the rich country can induce a decline in investment in the poor country via a "siphoning effect". Finally, we present some new empirical evidence regarding the link between LDC borrowing and per capita income.
- Federal Reserve Bank of Minneapolis. Research Department.
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