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The Great Moderation and the U.S. External Imbalance

  • 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)

The early 1980s marked the onset of two striking features of the current world macroeconomy: the fall in U.S. business cycle volatility (the ggreat moderationh) 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.

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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 24 (2006)
Issue (Month): S1 (December)
Pages: 209-225

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Handle: RePEc:ime:imemes:v:24:y:december:i:s1:p:209-225
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