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Global Imbalances and Financial Fragility

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  • Ricardo J. Caballero
  • Arvind Krishnamurthy

Abstract

The U.S. is currently engulfed in the most severe financial crisis since the Great Depression. A key structural factor behind this crisis is the large demand for riskless assets from the rest of the world. In this paper we present a model to show how such demand not only triggered a sharp rise in U.S. asset prices, but also exposed the U.S. financial sector to a downturn by concentrating risk onto its balance sheet. In addition to highlighting the role of capital flows in facilitating the securitization boom, our analysis speaks to the broader issue of global imbalances. While in emerging markets the concern with capital flows is in their speculative nature, in the U.S. the risk in capital inflows derives from the opposite concern: capital flows into the U.S. are mostly non-speculative and in search of safety. As a result, the U.S. sells riskless assets to foreigners, and in so doing, it raises the effective leverage of its financial institutions. In other words, as global imbalances rise, the U.S. increasingly specializes in holding its "toxic waste."

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File URL: http://hdl.handle.net/10.1257/aer.99.2.584
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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.99.2.584
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 99 (2009)
Issue (Month): 2 (May)
Pages: 584-88
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Handle: RePEc:aea:aecrev:v:99:y:2009:i:2:p:584-88

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References

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  1. Ricardo J. Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2006. "An Equilibrium Model of Global Imbalances and Low Interest Rates," 2006 Meeting Papers 894, Society for Economic Dynamics.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Global Imbalances: Links to Economic and Financial Stability
    by Guest Author in the big picture on 2011-02-21 15:09:05
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Cited by:
  1. Ben S. Bernanke & Carol Bertaut & Laurie Pounder DeMarco & Steven Kamin, 2011. "International capital flows and the returns to safe assets in the United States, 2003-2007," International Finance Discussion Papers 1014, Board of Governors of the Federal Reserve System (U.S.).
  2. Clovis Kerdrain & Isabell Koske & Isabelle Wanner, 2011. "Current Account Imbalances: can Structural Reforms Help to Reduce Them?," OECD Journal: Economic Studies, OECD Publishing, vol. 2011(1), pages 2.
  3. Noyer, C., 2011. "Global imbalances and financial stability," Financial Stability Review, Banque de France, issue 15, pages 107-112, February.
  4. Muradali V. Ibrahimo & Carlos P. Barros, 2009. "Unlearned Lessons from Risk, Debt Service, Bank Credit, and Asymmetric Information," Working Papers 2009/43, Department of Economics at the School of Economics and Management (ISEG), Technical University of Lisbon..
  5. Ugo Albertazzi & Ginette Eramo & Leonardo Gambacorta & Carmelo Salleo, 2011. "Securitization is not that evil after all," Temi di discussione (Economic working papers) 796, Bank of Italy, Economic Research and International Relations Area.
  6. Roe, Terry L. & Shane, Mathew & Heerman, Kari, 2011. "Macroeconomic Imbalances in the World Economy," Working Papers 109244, University of Minnesota, Center for International Food and Agricultural Policy.
  7. Maurizio Michael Habib, 2010. "Excess returns on net foreign assets - the exorbitant privilege from a global perspective," Working Paper Series 1158, European Central Bank.
  8. Agnes Benassy-Quere & Jean Pisani-Ferry, 2011. "Quel systeme monetaire international pour une economie mondiale en mutation rapide ?," Working Papers 2011-04a, CEPII research center.
  9. Piffaretti, Nadia F., 2009. "Reshaping the international monetary architecture : lessons from Keynes'plan," Policy Research Working Paper Series 5034, The World Bank.

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