Fear and Market Failure: Global Imbalances and ¿Self-Insurance¿

Marcus Miller and Lei Zhang

No 1606, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: This paper proposes an integrated framework to analyze jointly two key issues: the emergence of global imbalances and the precautionary motive for accumulating reserves. Standard models of general equilibrium would predict modest current account surpluses in the emerging markets if they face higher risk than the US itself. But, with pronounced Loss Aversion in emerging markets, their precautionary savings can generate substantial global imbalances, especially if there is an inefficient supply of global insurance. In principle, lower real interest rates will ensure that aggregate demand equals supply at a global level (though the required real interest may be negative). While a precautionary savings glut appears to be a temporary phenomenon, a process of correction triggered by a Sudden Stop in capital flows to the United States might lead to a hard landing.

Keywords: D52; WP-593; D51; E21; liquidity trap; loss aversion; E13; E12; E44; F32. stochastic dynamic general equilibrium (search for similar items in EconPapers)
Date: 2007-12
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Persistent link: https://EconPapers.repec.org/RePEc:idb:brikps:1606

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