Working Paper: CEPR ID: DP5573
Authors: Ricardo Caballero; Emmanuel Farhi; Pierre-Olivier Gourinchas
Abstract: Three of the most important recent facts in global macroeconomics - the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolio - appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) hetero- geneity in these regions? capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. Unlike the conventional wisdom, in the absence of a large change in (a) or (b), our model does not augur any catastrophic event. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment.
Keywords: capital flows; current account deficits; exchange rates; FDI; global portfolios; equilibrium growth; financial development asymmetries; interest rates; intermediation rents
JEL Codes: E0; F3; F4; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| slowdown in growth in regions with developed financial markets (E) (O16) | increased capital flows to the US (U) (F32) |
| increased capital flows to the US (U) (F32) | lower global interest rates (E43) |
| increased capital flows to the US (U) (F32) | greater importance of US assets in global portfolios (G15) |
| regions with high growth potential (R) (R50) | increased demand for US assets (E41) |
| increased capital flows to the US (U) (F32) | decline in interest rates (E43) |
| regions with high growth potential (R) unable to generate reliable financial assets (R50) | increased demand for US assets (U) (E41) |