31 - Capital Flows, Financial Crashes and Global Imbalances...

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Capital Flows, Financial Crashes and Global Imbalances Lemin Wu DEPARTMENT OF ECONOMICS UNIVERSITY OF CALIFORNIA AT BERKELEY February 19, 2011 1 / 25
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Global Imbalances: a Bird’s Eyes View Figure: Global Imbalances. Current account deficits as a fraction of 2 / 25
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Definitions A quick refresher on concepts: CA = NX + Net Factor Payments = Y - C - I - G + rB = S - I = ˙ B or ( B t + 1 - B t ) where: CA : Current Account NX : Net Exports or Trade Balance Y : Output (GDP) C : Aggregate Consumption I : Domestic Investment G : Government Expenditures S : National Saving (government + private) B : Net External Assets r : World real interest rate 3 / 25
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Interpretation? Three different but equivalent interpretations of the current account: 1. Trade approach ( CA = NX + NFP ) 2. ‘Absorption’ approach ( CA = Y + rB - ( C + I + G ) ) 3. ‘Intertemporal’ approach ( CA = S - I ) 4 / 25
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Modern theory: the intertemporal approach Focuses on the economic determinants of S and I I Domestic investment ( I ): at the margin, firms will invest until the marginal return to capital equals the cost of capital plus the depreciation rate ( MP K = r + δ ) I National saving ( S ): Saving is just the flip side of consumption. The central intuition of the theory comes from the ‘permanent income hypothesis’: households want to smooth their consumption over time . [Why?] 5 / 25
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Suppose a household receives a certain income stream { y s } s = t and faces a constant interest rate r . [Why until ?] I Write the dynamic budget constraint for that household: b t + 1 = ( 1 + r ) b t + y t - c t I Now isolate b t and substitute forward repeatedly: b t = 1 ( 1 + r ) ( c t - y t + b t + 1 ) = 1 ( 1 + r ) ( c t - y t ) + 1 ( 1 + r ) 2 ( c t + 1 - y t + 1 + b t + 2 ) = X s = t 1 ( 1 + r ) s - t + 1 ( c s - y s ) + lim T →∞ b T ( 1 + r ) T - t I Next isolate the present discounted value of consumption: X s = t 1 ( 1 + r ) s - t + 1 c s = b t + X s = t 1 ( 1 + r ) s
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This note was uploaded on 03/18/2011 for the course ECON 196 taught by Professor Pierre during the Spring '10 term at Berkeley.

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31 - Capital Flows, Financial Crashes and Global Imbalances...

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