The Saving Glut Explanation of Global Imbalances: the Role of Underinvestment

According to the “Saving Glut hypothesis”, global imbalances are caused by inefficiently high level of precautionary savings in financially underdeveloped regions, where agents have limited opportunity to diversify idiosyncratic risk. This paper generalizes the approach by modeling idiosyncratic risk in entrepreneurial activities, which can be only partially hedged. As a result, agents save too much and invest too little, relative to the efficient allocation, depressing production activities and the real interest rate. Capital account liberalization towards financially more advanced economies then produces an outflow of capital in search of safer investment, with the effect of further reducing domestic investment in countries with poor financial institutions. The model predicts welfare losses for less financially developed economies, and an increase in wealth inequality for advanced economies. Finally, the present analysis is able to explain the direct link between the financial crisis and global recession and the long run implications of worsening financial conditions on countries’ net external positions.Current Account, Financial Markets, Heterogeneity, Incomplete Markets, International Capital Movements

Reserve management and sovereign debt cost in a world with liquidity crises

The accumulation of large amount of sovereign reserves has fuelled an intense debate on the associated costs. In a world with liquidity crises and strategic default, we model a contracting game between international lenders and a country, which delivers the country's optimal portfolio choice and the cost of sovereign debt: at equilibrium, the sovereign allocates the borrowed resources to either liquid reserves or an illiquid and risky production project. We study how the opportunity cost of hoarding reserves is affected by the financial and technological characteristics of the economy. In line with recent empirical evidence, we find two important results: the cost of debt decreases in the level of reserves if the probability of liquidity shocks is high enough; however the cost of debt increases in reserves when the lenders anticipate that the country has an incentive to default after a liquidity shock. Indeed, we show that the country may choose to retain reserves instead of employing them to inject the liquidity needed to bring the production project to maturity.sovereign debt, international reserves, liquidity shock, strategic default

Global Imbalances: Saving and Investment Imbalances.

The goal of the present thesis is to analyze the diverging savings and investment behavior among countries. The purpose of this work is to suggest possible explanations for the so called .global imbalances.. In particular, the focus is on the negative asset positions of the US and the positive asset positions of emerging economies. The .rst two chapters study the effects of capital market liberalization among countries with structural differences and in particular different financial market depth. Global imbalances are generated by higher propensity to save as well as lower propensity to invest in financially underdeveloped countries, with respect to countries with better financial institutions. The analysis is able to reproduce medium term net capital flows towards financially advanced economies as a result of financial integration. Moreover, capital liberalization generates welfare losses for emerging economies and a reduction of their capital convergence towards the steady state. The third chapter focuses on one of the most debated aspects of international capital movements, namely sovereign reserve accumulation by emerging countries, as a form of precautionary saving to be employed to face liquidity crises. The analysis investigates the determinants of the opportunity cost of holding reserves, and finds that countries optimally decide to hold a positive amount of reserves. Countries’ lenders set the cost of debt by taking into account countries’ decisions and their economic and financial characteristics.

Global Imbalances : saving and investment imbalances

Defense Date: 13 April 2011Jury Members: Prof. Giancarlo Corsetti, University of Cambridge and EUI, Supervisor Prof. Árpád Ábrahám, EUI Prof. Mark Aguiar, University of Rochester Prof. Christopher Carroll, Johns Hopkins UniversityThe goal of the present thesis is to analyze the diverging savings and investment behavior among countries. The purpose of this work is to suggest possible explanations for the so called .global imbalances.. In particular, the focus is on the negative asset positions of the US and the positive asset positions of emerging economies. The .rst two chapters study the effects of capital market liberalization among countries with structural differences and in particular different financial market depth. Global imbalances are generated by higher propensity to save as well as lower propensity to invest in financially underdeveloped countries, with respect to countries with better financial institutions. The analysis is able to reproduce medium term net capital flows towards financially advanced economies as a result of financial integration. Moreover, capital liberalization generates welfare losses for emerging economies and a reduction of their capital convergence towards the steady state. The third chapter focuses on one of the most debated aspects of international capital movements, namely sovereign reserve accumulation by emerging countries, as a form of precautionary saving to be employed to face liquidity crises. The analysis investigates the determinants of the opportunity cost of holding reserves, and finds that countries optimally decide to hold a positive amount of reserves. Countries’ lenders set the cost of debt by taking into account countries’ decisions and their economic and financial characteristics

The Saving Glut Explanation of Global Imbalances. The Role of Underinvestment

According to the “Saving Glut hypothesis”, global imbalances are caused by inefficiently high level of precautionary savings in .nancially underdeveloped regions, where agents have limited opportunity to diversify idiosyncratic risk. This paper generalizes the approach by modeling idiosyncratic risk in entrepreneurial activities, which can be only partially hedged. As a result, agents save too much and invest too little, relative to the efficient allocation, depressing production activities and the real interest rate. Capital account liberalization towards financially more advanced economies then produces an outflow of capital in search of safer investment, with the effect of further reducing domestic investment in countries with poor financial institutions. The model predicts welfare losses for less financially developed economies, and an increase in wealth inequality for advanced economies. Finally, the present analysis is able to explain the direct link between the financial crisis and global recession and the long run implications of worsening financial conditions on countries’ net external position

Reserve management and sovereign debt cost in a world with liquidity crises

The accumulation of large amount of sovereign reserves has fuelled an intense debate on the associated costs. In a world with liquidity crises and strategic default, we model a contracting game between international lenders and a country, which delivers the country's optimal portfolio choice and the cost of sovereign debt: at equilibrium, the sovereign allocates the borrowed resources to either liquid reserves or an illiquid and risky production project. We study how the opportunity cost of hoarding reserves is affected by the financial and technological characteristics of the economy. In line with recent empirical evidence, we find two important results: the cost of debt decreases in the level of reserves if the probability of liquidity shocks is high enough; however the cost of debt increases in reserves when the lenders anticipate that the country has an incentive to default after a liquidity shock. Indeed, we show that the country may choose to retain reserves instead of employing them to inject the liquidity needed to bring the production project to maturity

Sovereign debt and reserves with liquidity and productivity crises

During the recent financial crisis, emerging economies have kept accumulating both sovereign reserves and debt. To account for this empirical fact, we model the optimal portfolio choice of a sovereign that is subject to liquidity and productivity shocks. We determine the equilibrium level of debt and its cost by solving a contracting game between sovereign and international lenders. Although raising debt increases the sovereign exposure to liquidity and productivity crises, the simultaneous accumulation of reserves can mitigate the negative effects of such crises. This mechanism rationalizes the complementarity between debt and reserves