Capital flows and the US ‘New Economy’ - consumption smoothing and risk exposure

Marcus Miller (), Olli Castrén () and Lei Zhang ()
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Olli Castrén: European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany, http://www.ecb.europa.eu/home/html/index.en.html

No 459, Working Paper Series from European Central Bank

Abstract: In an analytically tractable model of the global economy, we calculate the Pareto improvement where a country experiencing a favourable supply side shock consumes more against expected future output and spreads the risk by selling shares. With capital inflows to finance the ‘New Economy’ significantly exceeding the current account deficit, however, we show that selling shares globally at inflated prices – due to ‘irrational exuberance’ and distorted corporate incentives – can generate significant international transfers when the asset bubble bursts. The analysis complements recent econometric studies which appeal to financial factors to explain why the European economy was so strongly affected by the recent US downturn.

Keywords: Capital flows; moral hazard; international transmission of shocks. (search for similar items in EconPapers)
JEL-codes: F41 F32 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2005-03
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