Regulation Under External Credit Constraints: Theoretical Analysis and a CGE Illustration

Abstract:     
We investigate the interactions between optimal regulation and external credit constraints. When part of a regulated firm is owned by foreign investors, a credit-constrained country who wants to send profits abroad has to generate enough surplus in the trade account in order to compensate capital outflows. We show that the credit constraint translates into a constraint of maximum profits for the regulated firm. Overall efficiency in the regulated sector is reduced to maintain incentive compatibility in such a way that the production profile is not continuous. Manipulating the exchange rate may help relaxing the credit constraint. With a CGE model we verify the significance of our results for a real economy.

Number of Pages in PDF File: 29

Keywords: Optimal regulation, Credit constraints, International Trade

JEL Classification: D82, F32, L51

working papers series