Financial Integration, Credit Market Imperfections and Consumption Smoothing

Asli Leblebicioglu ()

No 651, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: Recent empirical research by Kose, Prasad and Terrones (2003) shows that financial integration is associated with higher consumption volatility in developing countries. This paper provides one possible explanation as to how international financial integration can increase consumption volatility in a developing country facing credit market imperfections. I use a two country international real business cycle model where the non-traded sector in the small country faces borrowing constraints due to contract enforceability problems. Financial integration provides households insurance against domestic risks that are amplified by the financial imperfections. If the international risk-sharing opportunities are nonexistent, households can secure themselves only by adjusting their labor effort, which leads to changes in sectorial output and terms of trade. The deterioration of the terms of trade acts as a dampening effect on consumption, causing it to be less volatile under financial autarky relative to financial integration

Keywords: international business cycles; financial integration (search for similar items in EconPapers)
JEL-codes: F41 (search for similar items in EconPapers)
Date: 2006
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (11)

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Journal Article: Financial integration, credit market imperfections and consumption smoothing (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed006:651

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