Liquidity constraints and global imbalances

International capital movements have been characterized by many changes in the last 15 years. These changes can be summarized by four facts. 1) The current account of the emerging and developing countries (EME countries hereafter) has turned from a deficit to a hefty surplus after 1998. The increasing gap observed in the 2000s between the current account deficit of the advanced economies (AE countries hereafter) and the current account surplus of the EME countries has been called "global imbalances". 2) The current account reversal in the EME countries occurred after many of these countries experienced balance of payment crises in the 1990s. 3) Global imbalances have reduced drastically since 2008 when the financial crisis erupted in the AE countries. 4) Both in 1998 and 2008, the saving rate in the EME countries changed more abruptly than the investment rate while the two rates followed closely the same path in the AE countries.

The objective of the present paper is to build a framework able to explain both the reversal in the current account balance experienced by the EME countries in 1998 and the strong reduction in global imbalances when the financial crisis hit the western economies at the end of the 2000s. We thus consider a two-country overlapping generations (OLG) model with exchange rates, in which firms may face liquidity constraints when households change the reallocation of their resources to short-term sovereign assets. Our paper is related to Jappelli and Pagano (1994) who consider an overlapping generations economy where households are credit constrained. Our model is also a deterministic framework but focuses on credit to firms and examine the effect of liquidity constraints to the on current accounts. If households have the choice between a short-term non-productive sovereign asset and a long-term productive corporate asset, any change in this allocation between the two will affect liquidity supplied to the firms. In an open-economy framework, this reallocation has also an impact on the current account.