Capital flows and the US ‘New Economy’: consumption smoothing and risk exposure
In an analytically tractable model of the global economy, we calculate the Pareto improvement where a country experiencing a favourable supply side shock consumes more against expected future output and spreads the risk by selling shares. With capital inflows to finance the ‘New Economy’ significantly exceeding the current account deficit, however, we show that selling shares globally at inflated prices – due to ‘irrational exuberance’ and distorted corporate incentives – can generate significant international transfers when the asset bubble bursts. The analysis complements recent econometric studies which appeal to financial factors to explain why the European economy was so strongly affected by the recent US downturn. JEL Classification: F41, F32, G15
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- Castrén, Olli & Miller, Marcus & Stiegert, Roger, 2003. "Growth expectations, capital flows and international risk sharing," Working Paper Series 0237, European Central Bank.
- Michael ARTIS & Ana Beatriz C. GALVÃO & Massimiliano MARCELLINO, 2003.
"The transmission mechanism in a changing world,"
Economics Working Papers
ECO2003/18, European University Institute.
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