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Endogenous Borrowing Constraints and Stagnation in Latin America

Latin America has had striking changes in economic performance over time. Following the recession and debt crises of the early 1980’s, per-capita consumption declined for about ten years; in the year 2004, it was not that different from what it was in 1980. This paper studies consumption stagnation in Latin America using a small open economy real business cycle model with endogenous borrowing limits, endogenous capital accumulation and domestic productivity growth, and international interest rate shocks. I find that the model does an excellent job matching the observed behavior of per-capita consumption and that the interaction of both productivity and international interest rate shocks with the borrowing limit is key. Furthermore I show that, unlike conventional wisdom, the participation constraint in this kind of model can bind not only in good times but also in prolonged bad times.

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