Working Paper: CEPR ID: DP6149
Authors: Enrique G. Mendoza; Vincenzo Quadrini; Josvctor Rosrull
Abstract: Large and persistent global financial imbalances need not be the harbinger of a world financial crash. Instead, we show that these imbalances can be the outcome of financial integration when countries differ in financial markets deepness. In particular, countries with more advanced financial markets accumulate foreign liabilities in a gradual, long-lasting process. Differences in financial deepness also affect the composition of foreign portfolios: countries with negative net foreign asset positions maintain positive net holdings of non-diversifiable equity and FDI. Abstracting from the potential impact of globalization on financial development, liberalization leads to sizable welfare gains for the more financially-developed countries and losses for the others. Three empirical observations motivate our analysis: (1) financial deepness varies widely even amongst industrial countries, with the United States ranking at the top; (2) the secular decline in the U.S. net foreign asset position started in the early 1980s, together with a gradual process of international capital markets liberalization; (3) net exports and current account balances are negatively correlated with indicators of financial development.
Keywords: international imbalances; portfolio composition; precautionary savings
JEL Codes: F36; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial integration (F30) | decline in net foreign asset position (F32) |
| financial deepness (O16) | composition of foreign asset portfolios (G15) |
| financial integration (F30) | portfolio composition (G11) |