Lending Constraints, Real Estate Prices and Business Cycles in Emerging Economies

This paper studies how international real interest rate shocks can drive business cycles in an emerging economy. We first present evidence that, in emerging economies, real interest rates and real estate prices are negatively correlated and real interest rates are countercyclical. Motivated by this evidence, we develop a model of a small open economy, where entrepreneurs are borrowing constrained and domestic lenders are lending constrained, with both constraints tied to real estate values. We demonstrate that a positive interest rate shock leads to a fall in real estate prices and, through the credit constraints, to a decline in output. The model is calibrated to data from Argentina. Simulation results show that our model can match the countercyclicality of real interest rates and the output pattern better than a model with the borrowing constraint but without the lending constraint. JEL Classification: E32, E44, F41