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Capital flows and the US ‘New Economy’: consumption smoothing and risk exposure

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  • Miller, Marcus
  • Castrén, Olli
  • Zhang, Lei

Abstract

In an analytically tractable model of the global economy, we calculate the Pareto improvement where a country experiencing a favourable supply side shock consumes more against expected future output and spreads the risk by selling shares. With capital inflows to finance the ‘New Economy’ significantly exceeding the current account deficit, however, we show that selling shares globally at inflated prices – due to ‘irrational exuberance’ and distorted corporate incentives – can generate significant international transfers when the asset bubble bursts. The analysis complements recent econometric studies which appeal to financial factors to explain why the European economy was so strongly affected by the recent US downturn. JEL Classification: F41, F32, G15

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0459.

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Date of creation: Mar 2005
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Handle: RePEc:ecb:ecbwps:20050459

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Related research

Keywords: Capital flows; international transmission of shocks; Moral Hazard;

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  1. Castrén, Olli & Miller, Marcus & Stiegert, Roger, 2003. "Growth expectations, capital flows and international risk sharing," Working Paper Series 0237, European Central Bank.
  2. Artis, Michael J & Galvão, Ana Beatriz C & Marcellino, Massimiliano, 2003. "The Transmission Mechanism in a Changing World," CEPR Discussion Papers 4014, C.E.P.R. Discussion Papers.
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Cited by:
  1. Marcus Miller & Lei Zhang, 2007. "Fear and Market Failure: Global Imbalances and “Self-Insurance”," Research Department Publications 4498, Inter-American Development Bank, Research Department.
  2. Marcus Miller & Lei Zhang, 2007. "Capital Flows, Interest Rates and Precautionary Behaviour: a model of Global Imbalances," Money Macro and Finance (MMF) Research Group Conference 2006 152, Money Macro and Finance Research Group.

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