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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. Jonathan Heathcote, 2003. "Financial Globalization and Real Regionalization," Working Papers gueconwpa~03-03-20, Georgetown University, Department of Economics.
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  3. Marianne Baxter & Mario J. Crucini, 1992. "Business cycles and the asset structure of foreign trade," Discussion Paper / Institute for Empirical Macroeconomics 59, Federal Reserve Bank of Minneapolis.
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