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The Great Moderation and the U.S. External Imbalance

Author

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  • Alessandra Fogli

    (Federal Reserve Bank of Minneapolis, New York University, and Center for Economic Policy Research)

  • Fabrizio Perri

    (University of Minnesota, Federal Reserve Bank of Minneapolis, New York University, Center for Economic Policy Research, and National Bureau of Economic Research)

Abstract

The early 1980s marked the onset of two striking features of the current world macroeconomy: the fall in U.S. business cycle volatility (the "great moderation") and the large and persistent U.S. 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 incentives to accumulate precautionary savings fall and this results in a permanent deterioration of its external balance. To assess how much of the current U.S. imbalance can be explained by this channel, we consider a standard two-country business cycle model in which households are subject to business cycle shocks they cannot perfectly insure against. The model suggests that a fall in business cycle volatility like that observed in the United States can account for about 20 percent of the actual U.S. external imbalance.

Suggested Citation

  • 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:ime:imemes:v:24:y:december:i:s1:p:209-225
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    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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