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The Saving Glut Explanation of Global Imbalances: the Role of Underinvestment

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  • Flavia Corneli

Abstract

According to the “Saving Glut hypothesis”, global imbalances are caused by inefficiently high level of precautionary savings in financially underdeveloped regions, where agents have limited opportunity to diversify idiosyncratic risk. This paper generalizes the approach by modeling idiosyncratic risk in entrepreneurial activities, which can be only partially hedged. As a result, agents save too much and invest too little, relative to the efficient allocation, depressing production activities and the real interest rate. Capital account liberalization towards financially more advanced economies then produces an outflow of capital in search of safer investment, with the effect of further reducing domestic investment in countries with poor financial institutions. The model predicts welfare losses for less financially developed economies, and an increase in wealth inequality for advanced economies. Finally, the present analysis is able to explain the direct link between the financial crisis and global recession and the long run implications of worsening financial conditions on countries’ net external positions.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2009/41.

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Date of creation: 2009
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Handle: RePEc:eui:euiwps:eco2009/41

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Keywords: Current Account; Financial Markets; Heterogeneity; Incomplete Markets; International Capital Movements;

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  1. Fabrizio Perri & Alessandra Fogli, 2007. "The "great moderation'' and the US external imbalance," 2007 Meeting Papers 41, Society for Economic Dynamics.
  2. Caballero, Ricardo & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of 'Global Imbalances' and Low Interest Rates," CEPR Discussion Papers 5573, C.E.P.R. Discussion Papers.
  3. Timotheos Angelidis, 2010. "Idiosyncratic Risk in Emerging Markets," The Financial Review, Eastern Finance Association, vol. 45(4), pages 1053-1078, November.
  4. Angeletos, George-Marios & Calvet, Laurent-Emmanuel, 2006. "Idiosyncratic production risk, growth and the business cycle," Journal of Monetary Economics, Elsevier, vol. 53(6), pages 1095-1115, September.
  5. Neng Wang, 2003. "Caballero Meets Bewley: The Permanent-Income Hypothesis in General Equilibrium," American Economic Review, American Economic Association, vol. 93(3), pages 927-936, June.
  6. Alessandra Bonfiglioli, 2006. "Financial integration, productivity and capital accumulation," Economics Working Papers 988, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Enrique G. Mendoza & Vincenzo Quadrini & José-Víctor Ríos-Rull, 2009. "On the Welfare Implications of Financial Globalization without Financial Development," NBER Chapters, in: NBER International Seminar on Macroeconomics 2007, pages 283-312 National Bureau of Economic Research, Inc.
  8. Oriana Bandiera & Gerard Caprio & Patrick Honohan & Fabio Schiantarelli, 2000. "Does Financial Reform Raise or Reduce Saving?," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 239-263, May.
  9. George-Marios Angeletos, 2007. "Uninsured Idiosyncratic Investment Risk and Aggregate Saving," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(1), pages 1-30, January.
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Cited by:
  1. Hans-Werner Sinn & John Hassler & Gilles Saint-Paul & Giancarlo Corsetti & Michael P. Devereux & Tim Jenkinson & Jan-Egbert Sturm & Xavier Vives, 2009. "Chapter 2: The Financial Crisis," EEAG Report on the European Economy, CESifo Group Munich, vol. 0, pages 59-122, 02.
  2. Gourinchas, Pierre-Olivier & Rey, Hélène, 2013. "External Adjustment, Global Imbalances and Valuation Effects," CEPR Discussion Papers 9566, C.E.P.R. Discussion Papers.

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