Events at CERGE-EI

Prof. Stephanie Schmitt-Grohé

Columbia University, New York, USA

Authors: Stephanie Schmitt-Grohé and Martin Uribe

Abstract: This paper establishes the existence of multiple equilibria in infinite-horizon open-economy models in which the value of tradable and nontradable endowments serves as collateral. In this environment, the economy is shown to display self-fulfilling financial crises in which pessimistic views about the value of collateral induce agents to deleverage. The paper shows that under plausible calibrations, there exist equilibria with underborrowing. This result stands in contrast to the overborrowing result stressed in the related literature. Underborrowing emerges in the present context because in economies that are prone to self-fulfilling financial crises, individual agents engage in excessive precautionary savings as a way to self-insure.

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