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The "Great Moderation" and the US External Imbalance

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  • Alessandra Fogli
  • Fabrizio Perri

Abstract

The early 1980s marked the onset of two striking features of the current world macro-economy: the fall in US business cycle volatility (the "great moderation") and the large and persistent US external imbalance. In this paper we argue that an external imbalance is a natural consequence of the great moderation. If a country experiences a fall in volatility greater than that of its partners, its relative incentives to accumulate precautionary savings fall and this results in an equilibrium permanent deterioration of its external balance. To assess how much of the current US imbalance can be explained by this channel, we consider a standard two country business cycle model in which households are subject to country specific shocks they cannot perfectly insure against. The model suggests that a fall in business cycle volatility like the one observed for the US relatively to other major economies can account for about 20% of the current total US external imbalance.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12708.

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Date of creation: Nov 2006
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Publication status: published as Alessandra Fogli & Fabrizio Perri, 2006. "The Great Moderation and the U.S. External Imbalance," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 24(S1), pages 209-225, December.
Handle: RePEc:nbr:nberwo:12708

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  1. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(4), pages 745-75, August.
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  9. Jonathan Heathcote, 2003. "Financial Globalization and Real Regionalization," Working Papers, Georgetown University, Department of Economics gueconwpa~03-03-20, Georgetown University, Department of Economics.
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