Working Paper: NBER ID: w12909
Authors: Enrique G. Mendoza; Vincenzo Quadrini; Jose-Victor Rios-Rull
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: financial integration; global imbalances; financial deepness
JEL Codes: E21; F3; F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Differences in financial deepness (F65) | Composition of foreign portfolios (G15) |
| Countries with deeper financial markets (O16) | Trade deficits (F14) |
| Countries with less developed markets (O10) | Trade surpluses (F19) |
| Gradual process of financial integration (F30) | Substantial and persistent global imbalances (F65) |
| Financial integration among countries with heterogeneous financial markets (F30) | Decline in the net foreign asset position of financially advanced countries (F32) |