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An Equilibrium Model of Global Imbalances and Low Interest Rates

  • Ricardo J. Caballero
  • Emmanuel Farhi

    ()

    (Economics Massachusetts Institute of Technology)

  • Pierre-Olivier Gourinchas

Three of the most important recent facts in global macroeconomics — the sustained rise in the US current account deficit, the stubborn decline in long run real rates, and the rise in the share of US assets in global portfolio — appear as anomalies from the perspective of conventional wisdom and models. Instead, in this paper we provide a model that rationalizes these facts as an equilibrium outcome of two observed forces: a) potential growth differentials among different regions of the world and, b) heterogeneity in these regions’ capacity to generate financial assets from real investments. In extensions of the basic model, we also generate exchange rate and FDI excess returns which are broadly consistent with the recent trends in these variables. Unlike the conventional wisdom, in the absence of a large change in(a) or (b), our model does not augur any catastrophic event. More generally, the framework is flexible enough to shed light on a range of scenarios in a global equilibrium environment

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 894.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:894
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  1. Gian-Maria Milesi-Ferretti & Philip R. Lane, 2005. "A Global Perspectiveon External Positions," IMF Working Papers 05/161, International Monetary Fund.
  2. 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.
  3. Frankel, Jeffrey & Cavallo, Eduardo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality," Working Paper Series rwp04-038, Harvard University, John F. Kennedy School of Government.
  4. Christian Broda & David E. Weinstein, 2006. "Globalization and the Gains from Variety," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 541-585, May.
  5. repec:cup:cbooks:9780521029018 is not listed on IDEAS
  6. Enrique G. Mendoza, 2007. "Financial Integration, Financial Deepness and Global Imbalance," 2007 Meeting Papers 746, Society for Economic Dynamics.
  7. Caballero, Ricardo & Farhi, Emmanuel & Gourinchas, Pierre-Olivier, 2006. "An Equilibrium Model of 'Global Imbalances' and Low Interest Rates," CEPR Discussion Papers 5573, C.E.P.R. Discussion Papers.
  8. Chinn, Menzie David & Frankel, Jeffrey A., 2006. "Will the Euro Eventually Surpass the Dollar As Leading International Reserve Currency?," Santa Cruz Department of Economics, Working Paper Series qt4hz4n9pb, Department of Economics, UC Santa Cruz.
  9. Soyoung Kim & Nouriel Roubini, 2004. "Twin Deficit or Twin Divergence? Fiscal Policy, Current Account, and Real Exchange Rate in the US," Econometric Society 2004 North American Winter Meetings 271, Econometric Society.
  10. Richard N. Cooper, 2005. "Living with Global Imbalances: A Contrarian View," Policy Briefs PB05-03, Peterson Institute for International Economics.
  11. Gourinchas, Pierre-Olivier & Rey, Hélène, 2005. "From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege," CEPREMAP Working Papers (Docweb) 0606, CEPREMAP.
  12. Sebastian Edwards, 2005. "Is the U.S. Current Account Deficit Sustainable? And If Not, How Costly is Adjustment Likely To Be?," NBER Working Papers 11541, National Bureau of Economic Research, Inc.
  13. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "The U.S. Current Account and the Dollar," NBER Working Papers 11137, National Bureau of Economic Research, Inc.
  14. Michael Dooley & David Folkerts-Landau & Peter Garber, 2005. "An essay on the revived Bretton Woods system," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  15. repec:tcd:wpaper:tep16 is not listed on IDEAS
  16. Kenneth Rogoff & William Brainard & George Perry, . "Global Current Account Imbalances and Exchange Rate Adjustments," Working Paper 33687, Harvard University OpenScholar.
  17. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2006. "Bubbles and capital flow volatility: Causes and risk management," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 35-53, January.
  18. Ben S. Bernanke, 2005. "The global saving glut and the U.S. current account deficit," Speech 77, Board of Governors of the Federal Reserve System (U.S.).
  19. repec:fip:fedgsq:y:2005:i:mar10 is not listed on IDEAS
  20. William R. Cline, 2005. "United States as a Debtor Nation, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 3993, May.
  21. Shang-Jin Wei & Jiandong Ju, 2006. "A Solution to Two Paradoxes of International Capital Flow," IMF Working Papers 06/178, International Monetary Fund.
  22. Richard H. Clarida, 2006. "G7 Current Account Imbalances: Sustainability and Adjustment," NBER Working Papers 12194, National Bureau of Economic Research, Inc.
  23. Ricardo Caballero & Emmanuel Farhi & Mohamad L. Hammour, 2004. "Speculative Growth: Hints from the US Economy," NBER Working Papers 10518, National Bureau of Economic Research, Inc.
  24. Martin Feldstein, 2005. "Monetary Policy in a Changing International Environment: The Role of Global Capital Flows," NBER Working Papers 11856, National Bureau of Economic Research, Inc.
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