Collateral constraints, external imbalances and heterogeneous agents in a two-country world

In this article, we focus on current account dynamics in large open economies characterized by debt-constrained heterogeneous agents and endogenous monetary policies. We incorporate three key features that have bulked large in the New Open Macroeconomics literature: i) home bias in trade ii) price rigidities and iii) durable goods (real properties). In order to limit agents’ willingness to consume and to (partially) insure creditors against the risk of default, we incorporate collateral constraints. We show that the impatience of collateral-constrained agents can be at the roots of permanent and sustainable external imbalances. Our model has a unique and dynamically determinate steady state, which is characterized by a positive level of debt. Our framework allows us to analyze the mechanisms at the roots of the (international) transmission of shocks and to focus on the implications of the monetary policy rules.