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Fear and Market Failure: Global Imbalances and “Self-Insurance”

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  • Marcus Miller
  • Lei Zhang

Abstract

This paper proposes an integrated framework to analyze jointly two key issues: the emergence of global imbalances and the precautionary motive for accumulating reserves. Standard models of general equilibrium would predict modest current account surpluses in the emerging markets if they face higher risk than the US itself. But, with pronounced Loss Aversion in emerging markets, their precautionary savings can generate substantial “global imbalances,” especially if there is an inefficient supply of global “insurance. ” In principle, lower real interest rates will ensure that aggregate demand equals supply at a global level (though the required real interest may be negative). While a precautionary savings glut appears to be a temporary phenomenon, a process of correction triggered by a “Sudden Stop” in capital flows to the United States might lead to a “hard landing. ”

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Paper provided by Inter-American Development Bank, Research Department in its series Research Department Publications with number 4498.

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Date of creation: Dec 2007
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Handle: RePEc:idb:wpaper:4498

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  1. Morten O. Ravn & Stephanie Schmitt-Grohe, 2004. "Deep Habits," 2004 Meeting Papers 208, Society for Economic Dynamics.
  2. E. Kohlscheen & M. P. Taylor, 2008. "International liquidity swaps: is the Chiang Mai Initiative pooling reserves efficiently?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 13(4), pages 323-332.
  3. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-42, Board of Governors of the Federal Reserve System (U.S.).
  4. Ricardo J Caballero & Emmanuel Farhi & Pierre-Olivier Gourinchas, 2006. "An equilibrum model of "global imbalances" and low interest rates," BIS Working Papers 222, Bank for International Settlements.
  5. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and The Exorbitant Privilege," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5220, C.E.P.R. Discussion Papers.
  6. Meissner, Christopher M & Taylor, Alan M, 2006. "Losing our Marbles in the New Century? The Great Rebalancing in Historical Perspective," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5917, C.E.P.R. Discussion Papers.
  7. Chari, V V & Kehoe, Patrick J & McGrattan, Ellen R, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 69(3), pages 533-63, July.
  8. David K. Backus & Bryan R. Routledge & Stanley E. Zin, 2005. "Exotic Preferences for Macroeconomists," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 319-414 National Bureau of Economic Research, Inc.
  9. Joshua Aizenman & Jaewoo Lee, 2005. "International Reserves," IMF Working Papers 05/198, International Monetary Fund.
  10. Michael Dooley & Peter Garber, 2005. "The cosmic risk: an essay on global imbalances and treasuries," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Feb.
  11. Driffill, John & Snell, Andrew, 2003. " What Moves OECD Real Interest Rates?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 35(3), pages 375-402, June.
  12. Philip R. Lane & Gian Maria Milesi-Ferretti, 2005. "Financial Globalisation and Exchange Rates," The Institute for International Integration Studies Discussion Paper Series, IIIS iiisdp044, IIIS.
  13. Hausmann, Ricardo & Sturzenegger, Federico, 2006. "Global Imbalances or Bad Accounting? The Missing Dark Matter in the Wealth of Nations," Working Paper Series rwp06-003, Harvard University, John F. Kennedy School of Government.
  14. Stephany Griffith-Jones & Krishnan Sharma, 2006. "GDP-Indexed Bonds: Making It Happen," Working Papers, United Nations, Department of Economics and Social Affairs 21, United Nations, Department of Economics and Social Affairs.
  15. Miller, Marcus & Castrén, Olli & Zhang, Lei, 2005. "Capital flows and the US ‘New Economy’: consumption smoothing and risk exposure," Working Paper Series, European Central Bank 0459, European Central Bank.
  16. David Backus & Espen Henriksen & Frederic Lambert & Christopher Telmer, 2009. "Current Account Fact and Fiction," NBER Working Papers 15525, National Bureau of Economic Research, Inc.
  17. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
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Cited by:
  1. Hume, Michael & Sentance, Andrew, 2009. "The global credit boom: Challenges for macroeconomics and policy," Journal of International Money and Finance, Elsevier, Elsevier, vol. 28(8), pages 1426-1461, December.
  2. Jeanne, Olivier & Rancière, Romain, 2008. "The Optimal Level of International Reserves For Emerging Market Countries: A New Formula and Some Applications," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6723, C.E.P.R. Discussion Papers.
  3. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 1-80.
  4. Kaltenbrunner, Annina & Nissanke, Machiko, 2009. "The Case for an Intermediate Exchange Rate Regime with Endogenizing Market Structures and Capital Mobility," Working Paper Series, World Institute for Development Economic Research (UNU-WIDER) UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
  5. Bini Smaghi, Lorenzo, 2007. "Global imbalances and monetary policy," Journal of Policy Modeling, Elsevier, Elsevier, vol. 29(5), pages 711-727.
  6. Chris Hunt, 2008. "Financial turmoil and global imbalances: the end of Bretton Woods II?," Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, vol. 71, September.

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