Lopsided Interest Rates in International Borrowing Markets

Yuanchen Cai () and Pablo Guerron
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Yuanchen Cai: Boston College

No 1088, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: This paper studies the macroeconomic consequences of asymmetric interest rate shocks at which small open economies borrow in international financial markets. Empirically, we document that borrowing spreads have two distinct regimes. The first one features stable borrowing rates, i.e., low risk. In contrast, the second phase displays large spreads with significant volatility and –asymmetry, high risk. We fit the spreads to a rich statistical process that allows for changes in the level, volatility, skewness and kurtosis of the spread’s distribution. Each of the spread regimes is estimated to be highly persistent. When we embed the estimated spreads in a standard small-open economy model, we find that 1) spread shocks alone explain a large fraction of the volatility in consumption and investment in the data; 2) interest shocks of similar magnitude have stronger contractionary effects in an economy where only low risk exists than in one with changes between high and low risk; 3) the transition from an economy with only low-risk interest rate shocks to one like in the data results in a significant and persistent contraction. The welfare cost of this transition equals 2.4% of consumption. Finally, an unexpected increase in skewness pushes the economy into a recession with output, consumption, and investment dropping by as much as 1%, 2%, and 5%, respectively. This contraction resembles those experienced by developing countries during sudden stop episodes.

Keywords: Borrowing spreads; risk; skewness; business cycles; welfare cost; sudden stops (search for similar items in EconPapers)
JEL-codes: C2 F4 (search for similar items in EconPapers)
Date: 2025-04-16
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