The 'Great Moderation' and the US External Imbalance

Alessandra Fogli () and Fabrizio Perri ()

No 6010, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The early 1980s marked the onset of two striking features of the current world macro-economy: the fall in US business cycle volatility (the “great moderation”) and the large and persistent US external imbalance. In this paper we argue that an external imbalance is a natural consequence of the great moderation. If a country experiences a fall in volatility greater than that of its partners, its relative incentives to accumulate precautionary savings fall and this results in an equilibrium permanent deterioration of its external balance. To assess how much of the current US imbalance can be explained by this channel, we consider a standard two country business cycle model in which households are subject to country specific shocks they cannot perfectly insure against. The model suggests that a fall in business cycle volatility like the one observed for the US relatively to other major economies can account for about 20% of the current total US external imbalance.

Keywords: business cycle volatility; current account; net foreign asset position; precautionary saving (search for similar items in EconPapers)
JEL-codes: F32 F34 F41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-dge
Date: 2006-12
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Working Paper: The "Great Moderation" and the US External Imbalance (2006)
Working Paper: The "Great Moderation" and the US External Imbalance (2006)
Journal Article: The Great Moderation and the U.S. External Imbalance (2006)
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