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The Great Moderation and the U.S. External Imbalance

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  • Alessandra Fogli

    (Federal Reserve Bank of Minneapolis, New York University, and Center for Economic Policy Research)

  • Fabrizio Perri

    (University of Minnesota, Federal Reserve Bank of Minneapolis, New York University, Center for Economic Policy Research, and National Bureau of Economic Research)

Abstract

The early 1980s marked the onset of two striking features of the current world macroeconomy: the fall in U.S. business cycle volatility (the ggreat moderationh) and the large and persistent U.S. external imbalance. In this paper, we argue that an external imbalance is a natural consequence of the great moderation. If a country experiences a fall in volatility greater than that of its partners, its incentives to accumulate precautionary savings fall and this results in a permanent deterioration of its external balance. To assess how much of the current U.S. imbalance can be explained by this channel, we consider a standard two-country business cycle model in which households are subject to business cycle shocks they cannot perfectly insure against. The model suggests that a fall in business cycle volatility like that observed in the United States can account for about 20 percent of the actual U.S. external imbalance.

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Bibliographic Info

Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 24 (2006)
Issue (Month): S1 (December)
Pages: 209-225

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Handle: RePEc:ime:imemes:v:24:y:december:i:s1:p:209-225

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Keywords: Business cycle volatility; Precautionary saving; Current account; Net foreign asset position;

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  1. Diego Comin & Mark Gertler, 2006. "Medium-Term Business Cycles," American Economic Review, American Economic Association, vol. 96(3), pages 523-551, June.
  2. Baxter, M. & Crucini, M., 1991. "Business Cycles and the Asset Structure of Foreign Trade," RCER Working Papers 316, University of Rochester - Center for Economic Research (RCER).
  3. David Backus & Espen Henriksen & Frederic Lambert & Chris Telmer, 2005. "Current Account Fact and Fiction," 2005 Meeting Papers 115, Society for Economic Dynamics.
  4. Olivier Blanchard & John Simon, 2001. "The Long and Large Decline in U.S. Output Volatility," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 32(1), pages 135-174.
  5. 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.
  6. Mendoza, Enrique G & Quadrini, Vincenzo & Ríos-Rull, José-Víctor, 2007. "Financial Integration, Financial Deepness and Global Imbalances," CEPR Discussion Papers 6149, C.E.P.R. Discussion Papers.
  7. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1991. "International real business cycles," Staff Report 146, Federal Reserve Bank of Minneapolis.
  8. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
  9. Andres Arias & Gary Hansen & Lee Ohanian, 2007. "Why have business cycle fluctuations become less volatile?," Economic Theory, Springer, vol. 32(1), pages 43-58, July.
  10. Sylvain Leduc & Keith Sill, 2003. "Monetary policy, oil shocks, and TFP: accounting for the decline in U.S. volatility," Working Papers 03-22, Federal Reserve Bank of Philadelphia.
  11. Jonathan Heathcote & Fabrizio Perri, 2002. "Financial Globalization and Real Regionalization," NBER Working Papers 9292, National Bureau of Economic Research, Inc.
  12. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 67-146.
  13. Sebastian Edwards, 2005. "Is the U.S. Current Account Deficit Sustainable? And If Not, How Costly is Adjustment Likely To Be?," NBER Working Papers 11541, National Bureau of Economic Research, Inc.
  14. James H. Stock & Mark W. Watson, 2005. "Understanding Changes In International Business Cycle Dynamics," Journal of the European Economic Association, MIT Press, vol. 3(5), pages 968-1006, 09.
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