Working Paper: NBER ID: w20933
Authors: Jaume Ventura; Alberto Martin
Abstract: We live in a new world economy characterized by financial globalization and historically low interest rates. This environment is conducive to countries experiencing credit bubbles that have large macroeconomic effects at home and are quickly propagated abroad. In previous work, we built on the theory of rational bubbles to develop a framework to think about the origins and domestic effects of these credit bubbles. This paper extends that framework to two-country setting and studies the channels through which credit bubbles are transmitted across countries. We find that there are two main channels that work through the interest rate and the terms of trade. The former constitutes a negative spillover, while the latter constitutes a negative spillover in the short run but a positive one in the long run. We study both cooperative and noncooperative policies in this world. The interest-rate and terms-of-trade spillovers produce policy externalities that make the noncooperative outcome suboptimal.
Keywords: credit bubbles; financial globalization; interest rates; macroeconomic effects
JEL Codes: E32; E44; O40
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credit bubbles (E51) | investment (G31) |
| credit bubbles (E51) | world interest rate (E43) |
| credit bubbles (E51) | crowding-in effect on borrowing (E62) |
| credit bubbles (E51) | negative interest rate spillover (E43) |
| credit bubbles (E51) | negative terms of trade effect (short run) (F14) |
| negative terms of trade effect (short run) (F14) | real appreciation (D46) |
| terms of trade effect (long run) (F14) | real depreciation (F31) |