Welfare effects of overborrowing in a two-period-two-country model

Schroder, Jurgen; Hennhofer, Dirk
June 2001
Journal of Asian Economics;Summer2001, Vol. 12 Issue 2, p173
Academic Journal
In this paper we discuss, in a two-country-two-period model, the consequences of debt crises arising from an overestimation of the productivity in the borrowing country. This overestimation leads to overinvestment and overconsumption in the borrowing country causing welfare losses. If the overestimation of the productivity is not too large, both the lending as well as the borrowing country can gain welfare compared to their autarky situations. If, however, the overestimation of the productivity is such that the welfare losses due to overinvestment and overconsumption in the borrowing country outweigh the welfare gains of international capital movements, least one country has to lose welfare compared to its autarky situation. If the overestimation of the productivity in the borrowing country is very large and if it is assumed that its period 2 consumption cannot fall below a minimum quantity, it is possible that due to the high period 1 consumption the borrowing country inevitably gains welfare compared to autarky and the lending country has to bear the losses. (C) 2001 Elsevier Science Inc. All rights reserved.


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