Domestic or global imbalances? Rising income risk and the fall in the US current account

Tobias Broer
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Tobias Broer: Stockholm University

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Abstract: When default leads to exclusion from financial markets, the implied loss of consumption smoothing opportunities is more costly when income volatility is high. A rise in income risk thus makes default less attractive, allowing creditors to relax borrowing limits. I show how, in an open economy, this endogenous financial deepening may reduce aggregate foreign assets in response to a rise in individual income risk, against the precautionary savings intuition. Conditions for this depend on whether default constrains complete or uncontingent contracts. The post-1980 rise in US household income risk strongly reduces foreign assets when domestic markets are complete or world interest rates low.

Date: 2014-05
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Published in Journal of Monetary Economics, 2014, 64, pp.47-67. ⟨10.1016/j.jmoneco.2014.02.002⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04490037

DOI: 10.1016/j.jmoneco.2014.02.002

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