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Fear and Market Failure: Global Imbalances and ¿Self-Insurance¿

  • Marcus Miller
  • Lei Zhang

This paper proposes an integrated framework to analyze jointly two key issues: the emergence of global imbalances and the precautionary motive for accumulating reserves. Standard models of general equilibrium would predict modest current account surpluses in the emerging markets if they face higher risk than the US itself. But, with pronounced Loss Aversion in emerging markets, their precautionary savings can generate substantial global imbalances, especially if there is an inefficient supply of global insurance. In principle, lower real interest rates will ensure that aggregate demand equals supply at a global level (though the required real interest may be negative). While a precautionary savings glut appears to be a temporary phenomenon, a process of correction triggered by a Sudden Stop in capital flows to the United States might lead to a hard landing.

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Paper provided by Inter-American Development Bank in its series IDB Publications (Working Papers) with number 6731.

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Date of creation: Dec 2007
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Handle: RePEc:idb:brikps:6731
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  1. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
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  5. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304R5, Cowles Foundation for Research in Economics, Yale University, revised Mar 2004.
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  8. Paul R. Krugman, 1998. "It's Baaack: Japan's Slump and the Return of the Liquidity Trap," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(2), pages 137-206.
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  10. C. Fred Bergsten & John Williamson (ed.), 2004. "Dollar Adjustment: How Far? Against What?," Peterson Institute Press: Special Reports, Peterson Institute for International Economics, number sr17, January.
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  15. repec:oup:restud:v:69:y:2002:i:3:p:533-63 is not listed on IDEAS
  16. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
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