World Finance and the US 'New Economy': Risk Sharing and Risk Exposure
The promising prospect of a ‘New Economy’ in the US attracted substantial equity inflows in the late 1990s, helping to finance the country’s burgeoning current account deficit. After peaking in 2000, however, US stocks fell by some 8 trillion dollars in value. To assess the welfare effects of international financial markets in this context, we use an analytically tractable (two-country, two-period, two-state) model of the global economy which allows the country experiencing the favourable supply side ‘shock’ to consume more against expected future output and to spread risk by selling shares. Since irrational exuberance and distorted corporate incentives can cause serious asset overvaluation, however, an asset price ‘bubble’ is also included, where market participants assign unwarranted likelihood to high pay offs. Relative to autarky, internationalizing financial markets does offer welfare gains. But these are small relative to the international wealth transfer that can arise from selling shares globally at inflated prices. Parameter variations suggest that this conclusion is quite robust. A calibrated exercise shows how capital inflows to finance the ‘New Economy’ can be twice the consumption-smoothing deficit on current account; and how market losses – due to ‘misfortune’ or ‘excess upside probability’ – can have global effects on consumption when the bubble bursts. The analysis complements recent econometric studies of the transmission mechanism which find that financial factors are needed to explain why the European economy was so strongly affected by the US downturn starting in 2002.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
|Date of creation:||Jan 2005|
|Date of revision:|
|Contact details of provider:|| Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ.|
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
|Order Information:|| Email: |
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Philippe Weil, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 105(1), pages 29-42.
- Ana Beatriz Galvão & Michael Artis & Massimiliano Marcellino, 2007.
"The transmission mechanism in a changing world,"
Journal of Applied Econometrics,
John Wiley & Sons, Ltd., vol. 22(1), pages 39-61.
- Michael ARTIS & Ana Beatriz C. GALVÃO & Massimiliano MARCELLINO, 2003. "The transmission mechanism in a changing world," Economics Working Papers ECO2003/18, European University Institute.
- Artis, Michael J & Galvão, Ana Beatriz C & Marcellino, Massimiliano, 2003. "The Transmission Mechanism in a Changing World," CEPR Discussion Papers 4014, C.E.P.R. Discussion Papers.
- Castrén, Olli & Miller, Marcus & Stiegert, Roger, 2003. "Growth expectations, capital flows and international risk sharing," Working Paper Series 0237, European Central Bank.
When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:4855. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.