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Global Imbalances and Low Interest Rates: An Equilibrium Model vs. A Disequilibrium Reality

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  • Frankel, Jeffrey

    (Harvard U)

Abstract

The most obvious explanation for the large and widening US current account deficit is the high budget deficit and low national saving. But a variety of clever economists have come up with 8 other, more sanguine, explanations: (1) the siblings are not twins, (2) investment boom, (3) low US private savings, (4) global savings glut , (5) “It’s a big world ” (6) valuation effects will pay for it, (7) “Intermediation rents…pay for the trade deficits,” and (8) China’s development strategy entails accumulating unlimited dollars. The impressive paper by Caballero, Farhis, and Gourinchas falls under category (7). Their theoretical model is innovative and interesting, and has the virtue of being able to explain the current account deficit together with the anomalously low long-term interest rates during 2001-2005. The basic idea is that fast growth in emerging markets coupled with their inability to generate local store of value instruments increases their demand for saving instruments from the developed countries. More growth potential in the United States than in Europe means that a larger share of global saving flows to US assets. Ultimately, however, I am not sure that it is the correct explanation, or a reason to consider the deficits sustainable, any more than the others. Their hypothesized collapse in the desirability of emerging market assets and stagnant growth in Europe and Japan fit the 1990s fairly well. But they don’t fit 2003-2006 as well, which is the puzzle period, that is, the period that featured the record US current account deficits coinciding with low long-term interest rates. Emerging markets have had a high capacity during 2003-06 to generate assets that others want. More persuasive is the hypothesis that the US continues to exploit the exorbitant privilege under which others accumulate dollars as reserves, but that this exclusive position of the dollar will not necessarily continue forever.

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Bibliographic Info

Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp06-035.

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Date of creation: Aug 2006
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Handle: RePEc:ecl:harjfk:rwp06-035

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  1. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege," CEPR Discussion Papers 5220, C.E.P.R. Discussion Papers.
  2. Chinn, Menzie & Frankel, Jeffrey, 2005. "Will the Euro Eventually Surpass the Dollar as Leading International Reserve Currency?," Working Paper Series rwp05-064, Harvard University, John F. Kennedy School of Government.
  3. Jiandong Ju & Shang-Jin Wei, 2006. "A Solution to Two Paradoxes of International Capital Flows," NBER Working Papers 12668, National Bureau of Economic Research, Inc.
  4. Lane, Philip R. & Milesi-Ferretti, Gian Maria, 2005. "A Global Perspective on External Positions," CEPR Discussion Papers 5234, C.E.P.R. Discussion Papers.
  5. 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.
  6. 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.
  7. Frankel, Jeffrey & Cavallo, Eduardo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality," Working Paper Series rwp04-038, Harvard University, John F. Kennedy School of Government.
  8. Richard N. Cooper, 2005. "Living with Global Imbalances: A Contrarian View," Policy Briefs PB05-03, Peterson Institute for International Economics.
  9. Martin Feldstein, 2005. "Monetary Policy in a Changing International Environment: The Role of Global Capital Flows," NBER Working Papers 11856, National Bureau of Economic Research, Inc.
  10. repec:tcd:wpaper:tep16 is not listed on IDEAS
  11. Michael Dooley & Peter Garber, 2005. "Is It 1958 or 1968? Three Notes on the Longevity of the Revived Bretton Woods System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 147-210.
  12. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2003. "An Essay on the Revived Bretton Woods System," NBER Working Papers 9971, National Bureau of Economic Research, Inc.
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Cited by:
  1. Jeffrey A. Frankel & Shang-Jin Wei, 2007. "Assessing China's Exchange Rate Regime," NBER Working Papers 13100, National Bureau of Economic Research, Inc.
  2. Pietro Alessandrini & Michele Fratianni, 2008. "Resurrecting Keynes to Stabilize the International Monetary System," Mo.Fi.R. Working Papers 1, Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences.
  3. Pavlova, Anna & Rigobon, Roberto, 2010. "An asset-pricing view of external adjustment," Journal of International Economics, Elsevier, vol. 80(1), pages 144-156, January.
  4. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock, 2008. "Current account sustainability and relative reliability," International Finance Discussion Papers 947, Board of Governors of the Federal Reserve System (U.S.).
  5. Stephanie E. Curcuru & Charles P. Thomas & Francis E. Warnock, 2008. "Current Account Sustainability and Relative Reliability," NBER Working Papers 14295, National Bureau of Economic Research, Inc.

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