Borrowing constraints and the trade balance-output comovement

The countercyclical trade balance ratio is one of the key stylized facts for open economies. The magnitude differs from country to country. Specifically, 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 group. This paper explores whether this difference is caused by international borrowing constraints imposed on emerging economies. By modeling the borrowing constraints as conditional on macroeconomic performance, the paper shows that when a positive shock takes place in emerging economies, $GDP$ increases and the borrowing constraint becomes less binding, which results in less incentive to accumulate foreign assets. When a negative shock is present, in contrast, $GDP$ decreases, and the representative household has to increase the trade balance to avoid the possibly binding borrowing constraints.