Credit constraints in equilibrium modeling of the economic and monetary union and global trade imbalances

Coeurdacier et al. (2015) forcefully attribute the following macro trends of the global economy to integration of emerging markets into worldwide capital markets and their rapid growth, particularly in Asia: (1) a large and persistent increase in private saving rates in emerging Asia in contrast to their steady decline in advanced economies, particularly in the USA; (2) emergence of global imbalances with external surpluses in emerging markets and external deficits in advanced economies; (3) a sustained fall in the world long-term interest rate. As part of the advanced economies, these macro trends also affect the European Economic and Monetary Union (EMU). In particular, since simultaneously with the development of external imbalances between Asia and the USA, current account and trade imbalances emerged within the EMU between core and periphery countries after Euro-related financial integration. It is natural to address the issues of global and EMU external imbalances within a unified framework in order to acknowledge the trade and financial interlinkages and spillovers among the EMU, Asia and the USA. To the best of our knowledge, as yet only Farmer and Ban (2015) developed a three-country (EMU, Asia, USA), two-region (EMU core, EMU periphery) intertemporal equilibrium model à la Buiter (1981) this was done in order to address both trade linkages between EMU sub-areas and extra-EMU trading partners forcefully pointed out by Chen et al. (2013), and the interest rate convergence not only within the EMU but also between Asia and USA (Angeletos and Panousi, 2011). However, while being able to attribute macro facts (2) and (3) mentioned above to intra-EMU and global financial integration as well as to the dynamic inefficiency of the world economy, Farmer and Ban (2015) could not explain the divergence of private saving rates between both Asia and the USA and EMU core and periphery. In contrast, Coeurdacier et al. (2015) are able to explain this macro fact by the interaction between growth differentials and household credit constraints – more severe in fast-growing economies. Thus, the objective of the paper is to introduce internationally differing household credit and growth rate differentials into the three-country overlapping generations (OLG) model in order to better reproduce better the empirically observed intra-EMU and global trade imbalances.

To pursue this objective, three-period instead of two-period lived (OLG), subjected to credit constraints on the future discounted wage income, and internationally diverging human capital accumulation are introduced into the three-country, two-region OLG model.