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Do differences in financial development explain the global pattern of current account imbalances?

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  • Joseph W. Gruber
  • Steven B. Kamin

Abstract

This paper addresses the popular view that differences in financial development explain the pattern of global current account imbalances. One strain of thinking explains the net flow of capital from developing to industrial economies on the basis of the industrial economies' more advanced financial systems and correspondingly more attractive assets. A related view addresses why the United States has attracted the lion's share of capital flows from developing to industrial economies; it stresses the exceptional depth, breadth, and safety of U.S. financial markets. ; In this paper we empirically test these hypotheses. Building on Chinn and Prasad (2003) and Gruber and Kamin (2007), we assess econometrically whether different measures of financial development explain the net flow of capital from developing to industrial economies, as well as the concentration of those flows toward the United States. We also assess whether differences in asset returns, an alternative measure of the attractiveness of financial assets, can explain the international pattern of capital flows. ; We find little evidence that differences in financial development help to explain the global pattern of current account imbalances. The measures of financial development generally do not explain either the net flow of capital from developing to industrial economies or, more specifically, the large U.S. current account deficits. Lower bond yields have been generally associated with lower current account balances (e.g., larger deficits) in industrial countries. However, U.S. bond yields have not been significantly lower than in other industrial economies, nor have expected equity earnings yields. This suggests, contrary to conventional wisdom, that U.S. financial assets have not been demonstrably more attractive than those of other industrial economies, and hence cannot explain the large U.S. deficit. ; Finally, we consider the alternative but related hypothesis that spending in the United States was uniquely responsive to the lower cost of credit stemming from capital inflows from developing countries, thus accounting for the outsized U.S. deficit. However, we found this hypothesis also to be weak, as household saving rates have declined throughout the industrial economies, not just in the United States.

Suggested Citation

  • Joseph W. Gruber & Steven B. Kamin, 2008. "Do differences in financial development explain the global pattern of current account imbalances?," International Finance Discussion Papers 923, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:923
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    References listed on IDEAS

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    1. Chinn, Menzie D. & Prasad, Eswar S., 2003. "Medium-term determinants of current accounts in industrial and developing countries: an empirical exploration," Journal of International Economics, Elsevier, vol. 59(1), pages 47-76, January.
    2. Enrique G. Mendoza, 2007. "Financial Integration, Financial Deepness and Global Imbalance," 2007 Meeting Papers 746, Society for Economic Dynamics.
    3. Eswar S. Prasad & Raghuram G. Rajan & Arvind Subramanian, 2007. "Foreign Capital and Economic Growth," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 153-230.
    4. Chinn, Menzie D. & Ito, Hiro, 2007. "Current account balances, financial development and institutions: Assaying the world "saving glut"," Journal of International Money and Finance, Elsevier, vol. 26(4), pages 546-569, June.
    5. Ravi Balakrishnan & Volodymyr Tulin & Tamim Bayoumi, 2007. "Globalization, Gluts, Innovation or Irrationality; What Explains the Easy Financing of the U.S. Current Account Deficit?," IMF Working Papers 07/160, International Monetary Fund.
    6. Ju, Jiandong & Wei, Shang-Jin, 2006. "A Solution to Two Paradoxes of International Capital Flows," CEPR Discussion Papers 5981, C.E.P.R. Discussion Papers.
    7. Richard N. Cooper, 2005. "Living with Global Imbalances: A Contrarian View," Policy Briefs PB05-03, Peterson Institute for International Economics.
    8. Boileau, Martin & Normandin, Michel, 2008. "Dynamics of the current account and interest differentials," Journal of International Economics, Elsevier, vol. 74(1), pages 35-52, January.
    9. repec:fip:fedgsq:y:2007:i:sep11 is not listed on IDEAS
    10. Ravi Balakrishnan & Volodymyr Tulin, 2006. "U.S. Dollar Risk Premiums and Capital Flows," IMF Working Papers 06/160, International Monetary Fund.
    11. Hiro Ito & Menzie Chinn, 2009. "East Asia and Global Imbalances: Saving, Investment, and Financial Development," NBER Chapters,in: Financial Sector Development in the Pacific Rim, East Asia Seminar on Economics, Volume 18, pages 117-150 National Bureau of Economic Research, Inc.
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    Cited by:

    1. Forbes, Kristin J., 2010. "Why do foreigners invest in the United States?," Journal of International Economics, Elsevier, vol. 80(1), pages 3-21, January.
    2. Reinhardt, Dennis & Ricci, Luca Antonio & Tressel, Thierry, 2013. "International capital flows and development: Financial openness matters," Journal of International Economics, Elsevier, vol. 91(2), pages 235-251.
    3. Carol C. Bertaut & Steven B. Kamin & Charles P. Thomas, 2008. "How long can the unsustainable U.S. current account deficit be sustained?," International Finance Discussion Papers 935, Board of Governors of the Federal Reserve System (U.S.).

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    Keywords

    Balance of payments ; Financial markets;

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