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

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Author Info
Marcus Miller () (Department of Economics, University of Warwick, Coventry, CV47AL, England, CSGR and CEPR.)
Olli Castrén () (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany)
Lei Zhang () (Corresponding author: Department of Economics, University of Warwick, Coventry, CV47AL, England, and CSGR.)

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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.

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Paper provided by European Central Bank in its series Working Paper Series with number 459.

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Length: 34 pages
Date of creation: Mar 2005
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Handle: RePEc:ecb:ecbwps:20050459

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Related research
Keywords: Capital flows moral hazard international transmission of shocks.

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Find related papers by JEL classification:
F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!] (restricted)
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  1. Katrin Tinn, 2005. "Optimal research in financial markets with heterogeneous private information a rational expectations model," Working Paper Series 493, European Central Bank. [Downloadable!]
  2. Miller, Marcus & Zhang, Lei, 2006. "Fear and Market Failure: Global Imbalances and 'Self-insurance'," CEPR Discussion Papers 6000, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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