International Lending and Borrowing in a Stochastic Sequence Equilibrium

This paper is a theoretical investigation of international lending andborrowing in the context of a general equilibrium model in which nationalproductivities are subject to random fluctuations and rates of timepreference differ among countries. International capital flows arise fromthe efforts of risk-averse households situated in different countries toself-insure against random productivity fluctuations. We establish theexistence of a rational expectations equilibrium in which the worldinterest rate is constant and strictly less than the rate of timepreference of the least impatient countries. The rate of time preference,solvency restrictions on borrowing, and balanced-budget fiscal policies arerigorously analyzed