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Title: An Equilibrium Model of 'Global Imbalances' and Low Interest Rates

Author(s): Ricardo Caballero, Emmanuel Farhi and Pierre-Olivier Gourinchas

Publication Date: March 2006

Keyword(s): capital flows, current account deficits, exchange rates, FDI, global portfolios and equilibrium, growth and financial development asymmetries, interest rates and intermediation rents

Programme Area(s): International Macroeconomics

Abstract: 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) hetero- geneity 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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Bibliographic Reference

Caballero, R, Farhi, E and Gourinchas, P. 2006. 'An Equilibrium Model of 'Global Imbalances' and Low Interest Rates'. London, Centre for Economic Policy Research.