Borrowing constraints and the trade balance-output comovement

The countercyclical trade balance ratio is among the key stylized facts about open economies. The magnitude of the correlation between the trade balance and output, however, differs from country to country. In particular, the trade balance ratio is more negatively correlated with output in emerging economies than in developed economies, suggesting that the trade balance is more sensitive to output changes in the former than in the latter. This paper explores whether this difference is caused by international borrowing constraints imposed on emerging economies.By modeling borrowing constraints as conditional on macroeconomic performance, this paper shows that when there is a positive shock takes place in an emerging economy, GDP increases and the borrowing constraint becomes less binding, resulting in a decreased incentive to accumulate foreign assets. When there is a negative shock, by contrast, GDP falls, and the representative household must increase the trade balance to avoid possible binding borrowing constraints.

► The trade balance is more negatively correlated with output in emerging economies. ► International borrowing constraints can explain this difference. ► Borrowing constraints is modeled as an upper limit. ► Borrowing constraints mitigates the consumption smoothing effect.