I am careful about using the words path-breaking, but I believe that the recent work by Enrique Mendoza, Vincenzo Quadrini and Jose-Victor Rios-Rull (MQR) may be just that. Their paper "Financial Integration, Financial Development and Global Imbalances" in the June 2009 Journal of Political Economy is eye-opening because it provides a different perspective on the global imbalance problem and the credit crisis.
The normal view, that is now generally accepted wisdom, is the savings glut story for global imbalances. The developing world, because of their high savings rate, funded the excessive consumption of the US. The consumer demand by the US created the trade imbalance deficit which was fed by a host of exporting countries which kept currency rates low and collected large increase in foreign reserves which were funneled back to the US. This flow of funds caused interest rates to be lower than normal in the US which served as catalyst for the current crisis.
MQR provides a different but very plausible story and model which can explain many of the stylized facts over the last two decades. The global imbalance issue was more than a savings glut problem but a structural issue. The great increase in financial integration over the last 25 years meant that capital was free to flow around the world. This flow of capital could mean money moving into the risky assets of emerging markets, but it could also mean capital flowing from exporting countries back to the developed world as these investors look for a risk free asset.
The reason for this risk free asset demand comes from the fact that there has not been strong financial development in many of these countries. The capital markets in many countries are illiquid and provide few acceptable low risk assets. The lack of financial development with the doors thrown open for capital to find safe havens was a recipe for the capital account imbalance problem.
Where are assets seeking risk free opportunities going to go if there are no local alternatives and capital is free to move around the world? But of course, they will go to US Treasuries, the safest and most liquid asset in the world. The issue is not that that there was such a great savings imbalance but the fact that the money that was saved in many countries flowed back up to the developed world. Money from the developed world moved down to emerging markets in an effort to gain diversification, but demand for safe assets moved funds back to developed markets.
With all of this money moving to Treasuries, it is no wonder that we had an interest rate conundrum. Instead of rising on a capital shortage, US rates declined from foreign demand flows.
One of the ways to solve the imbalance problem is to increase the development of local financial markets. Of course, if local markets do become more developed, US rates will have to rise because there will be less capital flowing into the safe assets in the developed world.
This new view does not supplant other stories about global imbalances but it places a new emphasis on the structural role of markets. This is an important new perspective which may lead to different thinking about how to regulate and develop markets.
The normal view, that is now generally accepted wisdom, is the savings glut story for global imbalances. The developing world, because of their high savings rate, funded the excessive consumption of the US. The consumer demand by the US created the trade imbalance deficit which was fed by a host of exporting countries which kept currency rates low and collected large increase in foreign reserves which were funneled back to the US. This flow of funds caused interest rates to be lower than normal in the US which served as catalyst for the current crisis.
MQR provides a different but very plausible story and model which can explain many of the stylized facts over the last two decades. The global imbalance issue was more than a savings glut problem but a structural issue. The great increase in financial integration over the last 25 years meant that capital was free to flow around the world. This flow of capital could mean money moving into the risky assets of emerging markets, but it could also mean capital flowing from exporting countries back to the developed world as these investors look for a risk free asset.
The reason for this risk free asset demand comes from the fact that there has not been strong financial development in many of these countries. The capital markets in many countries are illiquid and provide few acceptable low risk assets. The lack of financial development with the doors thrown open for capital to find safe havens was a recipe for the capital account imbalance problem.
Where are assets seeking risk free opportunities going to go if there are no local alternatives and capital is free to move around the world? But of course, they will go to US Treasuries, the safest and most liquid asset in the world. The issue is not that that there was such a great savings imbalance but the fact that the money that was saved in many countries flowed back up to the developed world. Money from the developed world moved down to emerging markets in an effort to gain diversification, but demand for safe assets moved funds back to developed markets.
With all of this money moving to Treasuries, it is no wonder that we had an interest rate conundrum. Instead of rising on a capital shortage, US rates declined from foreign demand flows.
One of the ways to solve the imbalance problem is to increase the development of local financial markets. Of course, if local markets do become more developed, US rates will have to rise because there will be less capital flowing into the safe assets in the developed world.
This new view does not supplant other stories about global imbalances but it places a new emphasis on the structural role of markets. This is an important new perspective which may lead to different thinking about how to regulate and develop markets.
No comments:
Post a Comment