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The B.E. Journal of Macroeconomics

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Ed. by Abraham, Arpad / Carceles-Poveda , Eva / Debortoli, Davide / Lambertini, Luisa / Nimark, Kristoffer / Schwartzman, Felipe / Wang, Pengfei

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Liquidity constraints, international trade, and optimal monetary policy

Wai-Ming Ho
  • Corresponding author
  • Department of Economics, York University, 4700 Keele Street, Toronto, ON M3J 1P3, Canada, Phone: 416 736 2100 ext.22319. Fax: 416 736 5987
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Published Online: 2017-09-15 | DOI: https://doi.org/10.1515/bejm-2015-0203


The availability of liquidity matters for an economy’s production and trade as firms need working capital to finance their operations. This paper studies the interaction between trade and capital flows operating through the liquidity allocations in the financial markets using a small-open-economy, overlapping-generations model. Working capital requirements distort the intratemporal consumption allocations. International capital inflows help easing liquidity in the domestic credit market, facilitating trade and improving the intratemporal allocation, while distorting the intertemporal allocation of the economy. We show how the government can use the Friedman rule and differentiated consumption taxes to address the tradeoff between the intratemporal and intertemporal distortions and achieve the second best optimum. Imposing a higher tax rate on imports can reduce the international borrowing to imports ratio and enhance the efficiency in using capital inflows to facilitate trade flows.

Keywords: excessive borrowing; Friedman rule; intratemporal and intertemporal trade; liquidity constraints; small open economy

JEL Classification: E52; E63; F41


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About the article

Published Online: 2017-09-15

Citation Information: The B.E. Journal of Macroeconomics, 20150203, ISSN (Online) 1935-1690, DOI: https://doi.org/10.1515/bejm-2015-0203.

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