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Global “Imbalances”
Ricardo Caballero
MIT
Background paper: “An Equilibrium Model of ‘Global Imbalances’ and Low Interest Rates”
R. J. Caballero, E. Farhi, P. O. Gourinchas
Global Imbalances Brunnen, June 2006 – p. 1/17
Current Account by Region
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
% of World GDP
USA, Australia, UK
Global Imbalances Brunnen, June 2006 – p. 2/17
Current Account by Region
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
% of World GDP
USA, Australia, UK EU, Japan
Global Imbalances Brunnen, June 2006 – p. 2/17
Current Account by Region
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
% of World GDP
USA, Australia, UK EU, Japan ROW
Global Imbalances Brunnen, June 2006 – p. 2/17
World and US Interest Rates
� � �� ����
� �
1990 1992 1994 1996 1998 2000 2002 2004
�� �world-short real US-long real
Global Imbalances Brunnen, June 2006 – p. 3/17
We need a model!
The (changing) conventional view: Mostly partialequilibrium or no model. Sudden Stop or 1980sanalogy.
Global Imbalances Brunnen, June 2006 – p. 4/17
We need a model!
The (changing) conventional view: Mostly partialequilibrium or no model. Sudden Stop or 1980sanalogy.
A simple asset-supply / asset-demand model.
Global Imbalances Brunnen, June 2006 – p. 4/17
We need a model!
The (changing) conventional view: Mostly partialequilibrium or no model. Sudden Stop or 1980sanalogy.
A simple asset-supply / asset-demand model.
Conclusion: The current situation is a reasonable andsustainable equilibrium given world heterogeneity ingrowth potential and financial development. (Note: thisis different from saying that it will persist...)
Global Imbalances Brunnen, June 2006 – p. 4/17
Basic Structure
Split the world: U − E − R
Global Imbalances Brunnen, June 2006 – p. 5/17
Basic Structure
Split the world: U − E − R
Key: Region’s are heterogeneous in growth potentialand financial development
Global Imbalances Brunnen, June 2006 – p. 5/17
Basic Structure
Split the world: U − E − R
Key: Region’s are heterogeneous in growth potentialand financial development
U : δ, g
Global Imbalances Brunnen, June 2006 – p. 5/17
Basic Structure
Split the world: U − E − R
Key: Region’s are heterogeneous in growth potentialand financial development
U : δ, g
E: δ, gE < g
(note: E competes with U in producing globalassets)
Global Imbalances Brunnen, June 2006 – p. 5/17
Basic Structure
Split the world: U − E − R
Key: Region’s are heterogeneous in growth potentialand financial development
U : δ, g
E: δ, gE < g
(note: E competes with U in producing globalassets)
R: δR < δ, gR ≥ g
(note: it matters a great deal who is growing fasterthan U )
Global Imbalances Brunnen, June 2006 – p. 5/17
Asset Supply
K −→ {Xt+s}
ր
{
δXt+s
financial asset
ց
{
(1 − δ) Xt+s
non capitalizable
Global Imbalances Brunnen, June 2006 – p. 6/17
Asset Supply
K −→ {Xt+s}
ր
{
δXt+s
financial asset
ց
{
(1 − δ) Xt+s
non capitalizable
Vt =δXt
r − g
Global Imbalances Brunnen, June 2006 – p. 6/17
Asset Demand
Long run:
Wt =(1 − δ)Xt
θ + g − r
Global Imbalances Brunnen, June 2006 – p. 7/17
Asset Demand
Long run:
Wt =(1 − δ)Xt
θ + g − r
Short run = Long run plus valuation effects (home bias)
Global Imbalances Brunnen, June 2006 – p. 7/17
Equilibrium
Global Imbalances Brunnen, June 2006 – p. 8/17
A U − E World
From early 1990s: European and Japanese slowdown(especially relative to US)
A Collapse in gE: NFA and Interest Rates
Global Imbalances Brunnen, June 2006 – p. 9/17
A U − R World
Shock: δR = δ − ∆δ
Global Imbalances Brunnen, June 2006 – p. 10/17
A U − R World
Shock: δR = δ − ∆δ
Interpretation? The perception that, in the aggregate,financial instruments are less sound; following, e.g., thecollapse of a bubble, corporate governance problems,loss of intermediation capital, decline in property rightsprotection, increased perception of ‘crony capitalism’....(factors present in Asian/Russian crises)
Global Imbalances Brunnen, June 2006 – p. 10/17
,
(Supply)
(Demand)
,
(Supply)
(Demand)
rUa
V U/XU
W U/XU
V/XW/X
r
rRa V R/XR
W R/XR
V/XW/X
r
r
A
B C
A∗
B∗ C∗
NAU < 0
NAR > 0
D∗
The Metzler diagram for a permanent drop in δR
Global Imbalances Brunnen, June 2006 – p. 11/17
A U − R World
A Collapse in δR when gR = g: NFA and Interest Rates
Larger if gR > g!
Global Imbalances Brunnen, June 2006 – p. 12/17
The Three-Region World
A Collapse in gE followed by a collapse in δR: NFA and InterestRates
Global Imbalances Brunnen, June 2006 – p. 13/17
Other Topics in the Paper
Investment and FDI
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper
Investment and FDI
FDI as a substitute for domestic financialdevelopment
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper
Investment and FDI
FDI as a substitute for domestic financialdevelopment
Large gross flows and permanent trade deficits inthe US (and Europe?). Interest rates rise over time.
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper
Investment and FDI
FDI as a substitute for domestic financialdevelopment
Large gross flows and permanent trade deficits inthe US (and Europe?). Interest rates rise over time.
Exchange rates
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper
Investment and FDI
FDI as a substitute for domestic financialdevelopment
Large gross flows and permanent trade deficits inthe US (and Europe?). Interest rates rise over time.
Exchange rates
A side show
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper
Investment and FDI
FDI as a substitute for domestic financialdevelopment
Large gross flows and permanent trade deficits inthe US (and Europe?). Interest rates rise over time.
Exchange rates
A side show
Initial appreciation of dollar and then gradualdepreciation of the order of 20-30%.
Global Imbalances Brunnen, June 2006 – p. 14/17
Other Topics in the Paper (2)
Reversals
Global Imbalances Brunnen, June 2006 – p. 15/17
Other Topics in the Paper (2)
Reversals
Recovery in Japan, Germany...
Global Imbalances Brunnen, June 2006 – p. 15/17
Other Topics in the Paper (2)
Reversals
Recovery in Japan, Germany...
Financial deepening in Asia...
Global Imbalances Brunnen, June 2006 – p. 15/17
Other Topics in the Paper (2)
Reversals
Recovery in Japan, Germany...
Financial deepening in Asia...
Fiscal deficits, savings-glut, and so on...
Global Imbalances Brunnen, June 2006 – p. 15/17
Final Remarks
Is the current situation sustainable?
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Is the current situation sustainable? Yes
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Is the current situation sustainable? Yes
Is it likely to persist for the indefinite future?
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Is the current situation sustainable? Yes
Is it likely to persist for the indefinite future? No
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Is the current situation sustainable? Yes
Is it likely to persist for the indefinite future? No
A key distinction: Errors of framework versus shocks
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Is the current situation sustainable? Yes
Is it likely to persist for the indefinite future? No
A key distinction: Errors of framework versus shocks
Recovery in Japan and GermanyFinancial deepening in AsiaA sharp decline in the price of oilA sharp decline in China and neighborsSomething we can’t imagine at this time (pandemic,etc.)
Global Imbalances Brunnen, June 2006 – p. 16/17
Final Remarks
Do I like the current equilibrium?
Global Imbalances Brunnen, June 2006 – p. 17/17
Final Remarks
Do I like the current equilibrium? No, a leveraged giantis always worrisome...
Global Imbalances Brunnen, June 2006 – p. 17/17
Final Remarks
Do I like the current equilibrium? No, a leveraged giantis always worrisome... but
Global Imbalances Brunnen, June 2006 – p. 17/17
Final Remarks
Do I like the current equilibrium? No, a leveraged giantis always worrisome... but
It is an equilibrium, given observed growth and financialdevelopment heterogeneity, not an anomaly that has togo away just because it doesn’t fit conventionalwisdom...
Global Imbalances Brunnen, June 2006 – p. 17/17
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