Working Paper: CEPR ID: DP9424
Authors: Jonathan Heathcote; Fabrizio Perri
Abstract: This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
Keywords: international business cycles; international risk sharing; long-run growth; long-run risk; real exchange rate
JEL Codes: F21; F32; F36; F41; F43; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| faster long-run growth (O49) | increase in savings behavior (D14) |
| inefficient allocation of resources (D61) | significant welfare costs (D69) |
| partial financial liberalization (F30) | decrease in welfare (I38) |
| observed data on international comovement of consumption and capital flows (F30) | align with efficiency (D61) |
| theoretical models (C20) | indicate inefficiencies (D61) |