DP7134 What Drives US Foreign Borrowing? Evidence on External Adjustment to Transitory and Permanent Shocks

Author(s): Giancarlo Corsetti, Panagiotis T Konstantinou
Publication Date: January 2009
Keyword(s): Consumption Smoothing, Current Account, International Adjustment Mechanism, Intertemporal Approach to the Current Account, Net Foreign Wealth, Permanent-Transitory Decomposition
JEL(s): C32, E21, F32, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7134

The joint dynamics of US net output, consumption, and (valuation-adjusted) foreign assets and liabilities, characterized empirically following Lettau and Ludvigson [2004], is shown to be strikingly consistent with current account theory. While US consumption is virtually insulated from transitory shocks, these contribute considerably to the variation in net output and, even more so, in gross foreign positions, arguably smoothing temporary variations in returns. A single permanent shock ? naturally interpreted as a productivity shock ? raises consumption swiftly while causing net output to adjust only gradually. This leads to persistent, procyclical external deficits but, interestingly, moves gross assets and liabilities in the same direction.