Working Paper: CEPR ID: DP3440
Authors: Aart Kraay; Jaume Ventura
Abstract: Faced with income fluctuations, countries smooth their consumption by raising savings when income is high, and vice versa. How much of these savings do countries invest at home and abroad? In other words, what are the effects of fluctuations in savings on domestic investment and the current account? In the long-run, we find that countries invest the marginal unit of savings in domestic and foreign assets in the same proportions as in their initial portfolio, so that the latter is remarkably stable. In the short run, we find that countries invest the marginal unit of savings mostly in foreign assets, and only gradually do they rebalance their portfolio back to its original composition. This means that countries not only try to smooth consumption, but also domestic investment. To achieve this, they use foreign assets as a buffer stock.
Keywords: current account adjustment; international capital flow; short and long run
JEL Codes: F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fluctuations in savings (E21) | fluctuations in the current account (F32) |
| marginal unit of savings (E21) | investment in domestic and foreign assets (F21) |
| marginal unit of savings (E21) | investment in foreign assets (F21) |
| investment in foreign assets (F21) | rebalancing portfolios (G11) |
| adjustment costs to investment (G31) | fluctuations in the current account (F32) |
| current account surplus (F32) | diminishing as savings return to normal (E21) |
| long-run correlation between investment and the current account (F32) | weak (I14) |
| short-run correlation between investment and the current account (F32) | consistently negative (D91) |