The Library

Fear and market failure: global imbalances and 'self-insurance'

Tools

Miller, Marcus and Zhang, Lei (2006) Fear and market failure: global imbalances and 'self-insurance'. Discussion Paper. London: Centre for Economic Policy Research (Great Britain). Discussion paper (Centre for Economic Policy Research (Great Britain)) (No.600).

Preview

PDF
WRAP_Miller_CEPR-DP6000[1].pdf - Requires a PDF viewer such as GSview, Xpdf or Adobe Acrobat Reader
Download (320Kb)

Official URL: http://www.cepr.org/pubs/new-dps/dplist.asp?dpno=6...

Abstract

Two key issues are examined in an integrated framework: 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’. A combination of fear and market failure generates imbalances as a general equilibrium outcome. In principle, lower real interest rates will ensure aggregate demand equals supply at a global level: but disequilibrium may result if the required real interest rate is negative. A precautionary savings glut appears to us to be a temporary phenomenon, however, destined for correction as and when adequate reserve levels are achieved. If the process of correction is triggered by ‘Sudden Stop’ on capital flows to the US, might this not lead to 'hard landing' that is forecast by several leading macroeconomists? When precautionary saving is combined with financial panic, history offers no guarantee of full employment.

Item Type:

Working or Discussion Paper (Discussion Paper)

Subjects:

H Social Sciences > HG Finance

Divisions:

Faculty of Social Sciences > Economics

Library of Congress Subject Headings (LCSH):

Liquidity (Economics), Loss aversion, Stochastic processes, Equilibrium (Economics), Saving and investment

Series Name:

Discussion paper (Centre for Economic Policy Research (Great Britain))

Publisher:

Centre for Economic Policy Research (Great Britain)

Place of Publication:

London

Official Date:

December 2006

Dates:

Date	Event
December 2006	Published

Number:

No.600

Number of Pages:

Status:

Not Peer Reviewed

Access rights to Published version:

Open Access

Funder:

Economic and Social Research Council (Great Britain) (ESRC)

Grant number:

RES-051-27-0125 (ESRC), RES-156-25-0032 (ESRC)

References:

Aizenman, Joshua and Jaewoo Lee (2005), “International Reserves: Precautionary vs. Mercantilist Views, Theory and Evidence”, IMF Working Paper, WP/05/198.
Bailey, A., S. Millard and S. Wells. (2001). “Capital Flows and Exchange Rates.” Bank of England Quarterly Bulletin, Autumn: 310-318.
Backus, D; B Routledge, and SE Zin (2004), “Exotic Preferences for Macroeconomists”, NBER Working Paper 10597, June.
Backus, David; Espen Henriksen; Frederic Lambert; and, Chris Telmer (2006), “Current Account Fact and Fiction,” Working paper, New York University.
Bergsten, Fred and John Williamson (Eds) (2004) Dollar Adjustment: How Far? Against What? IIE:Washington DC.
Buiter, W. (2006), “Dark Matter or Cold Fusion?”, Global Economics Paper No: 136, Goldman Sachs. See also: http://www.nber.org/~wbuiter/dark.pdf
Caballero, Ricardo Emmanuel Farhi and Pierre-Olivier Gourinchas (2006), "An Equilibrium Model of "Global Imbalances" and Low Interest Rates", MIT Department of Economics, Working paper: 06-02
Campbell, John Y. and John H. Cochrane (1999), “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behaviour,” Journal of Political Economy, vol. 107 no 2, 205-251.
Carroll, Christopher D., Jody Overland, and David N. Weil (2000), “Saving and Growth with Habit Formation,” American Economic Review, vol. 90 no 3, 341-355.
Chari, V. V., Patrick J. Kehoe, and Ellen McGrattan (2002), “Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?” Review of Economic Studies, vol. 69 no 3, 533-563
Cooper, Richard (2005), “Living with Global Imbalances: A Contrarian View”, Policy Briefs in International Economics, IIE. November.
Dooley, Michael, David Folkerts-Landau and Peter Garber (2004) "The revived Bretton Woods system," International Journal of Finance & Economics, vol. 9(4), pages 307-313.
Dooley, Michael and Peter Garber, (2005) "The cosmic risk: an essay on global imbalances and treasuries," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
Driffill, J. and A. and Snell (2003), "What moves OECD real interest rates?", Journal of Money, Credit and Banking, vol. 35 no 3, 375 - 402.
Eichengreen, Barry and Yung Park (2006) “Global Imbalances: Implications for Emerging Asia and Latin America”. Presented at “Global Imbalances and Risk Management Has the center become the periphery?”, Madrid, May.
Gourinchas, P. and H. and Rey (2006), “From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege”, In Richard Clarida, ed., G7 Current Account Imbalances: Sustainability and Adjustment, University of Chicago Press, forthcoming.
Griffith-Jones, Stephany and Krishnan, Sharma (2006) “GDP-Indexed Bonds: Making it Happen”. DESA Working Paper No. 21, Department of Economic and Social Affairs.
Griffith-Jones, Stephany and Robert Shiller (2006), “A bond that insures against instability”, Financial Times, July 10th.
Hanson, James (2006) “Global Imbalances: Resolving the US Peso Problem” Presented at “Global Imbalances and Risk Management: Has the center become the periphery?”, Madrid, May.
Hausmann, R. and F. Sturzenegger. 2005. “Global imbalances or bad accounting? The missing dark matter in the wealth of nations.” Mimeo, Harvard University.
Jeanne, Olivier and Romain Ranciere (2006) “The Optimal Level of International Reserves for Emerging Market Economies: Formulas and Applications”, Mimeo IMF
Kahneman, D., & Tversky, A. (1979) “Prospect theory: An analysis of decision under risk”. Econometrica, 47, 263-291.
King, Mervyn (2006), “Reform of the International Monetary Fund”, speech at the Indian Council for Research on International Economic Relations (ICRIER) in New Delhi, India. 20 February.
Kohlscheen, Emanuel and Mark Taylor (2006) “International Liquidity Swaps: Is the Chiang Mai Initiative Efficiently Pooling Reserves?” Mimeo University of Warwick
Krugman, Paul (1998) “It’s Baaak:Japan’s Slump and the Return of the Liquidity Trap” Brookings Papers on Economic activity, No.2, pp 137-205.
Lane, P. R. and G. M. Milesi-Ferretti (2004), “Financial globalization and exchange rates.” CEPR DP: No. 4745.
Meissner, Christopher and Alan Taylor (2006), “Losing our Marbles in the New Century? The Great Rebalancing in Historical Perspective” Mimeo, Cambridge.
Miller, Marcus, Olli Castren and Lei Zhang (2005), “Capital flows and the US ‘New Economy’: consumption smoothing and risk exposure”. ECB Working Paper No. 459 (March).
Miller, Marcus, Olli Castren and Lei Zhang (2006), “Irrational Exuberance” and Capital Flows for the US New Economy: A Simple Global Model, mimeo, University of Warwick. (Forthcoming in International Journal of Finance & Economics.)
Nolan, Peter (2004), China at the Crossroads, Oxford: Polity
Obstfeld, M. and K. Rogoff (2005), Foundations of international macroeconomics, Cambridge MA: MIT Press
Obstfeld, M. and K. Rogoff (2005), “Global Current Account Imbalances and Exchange Rate Adjustments”, Brookings Papers on Economic Activity.
Ravn, Morten, Stephanie Schmitt-Grohe and Martin Uribe (2004), “Deep Habits”, CEPR Discussion Paper 4269.
Roubini, Nouriel (2006), “Mind the gap”, Global Economy and International Finance. See http://www.rgemonitor.com/blog/roubini/.
Setser, Brad (2006) “Bretton Woods 2: Is it Sustainable?” Paper presented at “Global Imbalances and Risk Management Has the center become the periphery?”, Madrid, May.
Stiglitz, Joseph (2006), Making globalization work, Penguin: London.
Thamotheram, Craig (2006) “Sustainability of global imbalances”. MSc dissertation, University of Warwick
Wolf, Martin (2005), “Will Globalisation Survive?”, World Economics, 6(4), pp.1-10.
Wolf, Martin (2006), “Fixing Global Finance”, SAIS Lecture series, March 28-30.