Working Paper: NBER ID: w17796
Authors: Michael B. Devereux; Ozge Senay; Alan Sutherland
Abstract: Over the one and a half decades prior to the global financial crisis, advanced economies experienced a large growth in gross external portfolio positions. This phenomenon has been described as Financial Globalization. Over roughly the same time frame, most of these countries also saw a substantial fall in the level and variability of inflation. Many economists have conjectured that financial globalization contributed to the improved performance in the level and predictability of inflation. In this paper, we explore the causal link running in the opposite direction. We show that a monetary policy rule which reduces inflation variability leads to an increase in the size of gross external positions, both in equity and bond portfolios. This is a highly robust prediction of open economy macro models with endogenous portfolio choice. It holds across many different modeling specifications and parameterizations. We also present preliminary empirical evidence which shows a negative relationship between inflation volatility and the size of gross external positions.
Keywords: inflation variability; financial globalization; monetary policy; gross external positions
JEL Codes: F3; F33; F4; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy rule which reduces inflation variability (E63) | increase in the size of gross external positions (F32) |
| Decrease in inflation variability (E31) | increase in the size of gross external positions (F32) |
| Increase in feedback coefficient on inflation in the Taylor rule (E31) | decrease in inflation variability (E31) |
| Decrease in inflation variability (E31) | larger gross positions (E19) |
| Return variability effect and return-income correlation effect (C32) | expansion of gross positions (F29) |