Research Discussion Papers, Bank of Finland
No 27/2014:
Leverage constraints and real interest rates
Jukka Isohätälä, Feo Kusmartsev, Alistair Milne ()
and Donald Robertson
Abstract: This paper investigates the macroconomics of real interest
rates when there are constraints on debt fi nance, used both for insurance
against income shocks and transferability of resources over time. We amend
a standard continuous-time deterministic model of international exchange,
with patient and impatient countries, introducing country level shocks
fully diversifi able at the global level. A series of shocks that push one
country towards its leverage limit induces substantial pre-cautionary
saving and a collapse of real interest rate relative to the deterministic
benchmark. We discuss the resulting dynamics of interest rates and the
broader implications for macroeconomic modelling.
Keywords: borrowing constraints; debt management; incomplete financial markets; international macroeconomics; finance and macroeconomics; macroeconomic propagation; precautionary saving; (follow links to similar papers)
JEL-Codes: E44; (follow links to similar papers)
60 pages, November 6, 2014
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