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32. International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007
- Author:
- Ben S. Bernanke, Carol C. Bertaut, Laurie Pounder DeMarco, and Steve Kamin
- Publication Date:
- 02-2011
- Content Type:
- Working Paper
- Institution:
- Board of Governors of the Federal Reserve System
- Abstract:
- A broad array of domestic institutional factors--including problems with the originate-to-distribute model for mortgage loans, deteriorating lending standards, deficiencies in risk management, conflicting incentives for the GSEs, and shortcomings of supervision and regulation--were the primary sources of the U.S. housing boom and bust and the associated financial crisis. In addition, the extended rise in U.S. house prices was likely also supported by long-term interest rates (including mortgage rates) that were surprisingly low, given the level of short-term rates and other macro fundamentals--a development that Greenspan (2005) dubbed a "conundrum." The "global saving glut" (GSG) hypothesis (Bernanke, 2005 and 2007) argues that increased capital inflows to the United States from countries in which desired saving greatly exceeded desired investment--including Asian emerging markets and commodity exporters--were an important reason that U.S. longer-term interest rates during this period were lower than expected. This essay investigates further the effects of capital inflows to the United States on U.S. longer-term interest rates; however, we look beyond the overall size of the inflows emphasized by the GSG hypothesis to examine the implications for U.S. yields of the portfolio preferences of foreign creditors. We present evidence that, in the spirit of Caballero and Krishnamurthy (2009), foreign investors during this period tended to prefer U.S. assets perceived to be safe. In particular, foreign investors--especially the GSG countries--acquired a substantial share of the new issues of U.S. Treasuries, Agency debt, and Agency-sponsored mortgage-backed securities. The downward pressure on yields exerted by inflows from the GSG countries was reinforced by the portfolio preferences of other foreign investors. We focus particularly on the case of Europe: Although Europe did not run a large current account surplus as did the GSG countries, we show that it leveraged up its international balance sheet, issuing external liabilities to finance substantial purchases of apparently safe U.S. "private-label" mortgage-backed securities and other fixed-income products. The strong demand for apparently safe assets by both domestic and foreign investors not only served to reduce yields on these assets but also provided additional incentives for the U.S. financial services industry to develop structured investment products that "transformed" risky loans into highly-rated securities. Our findings do not challenge the view that domestic factors, including those listed above, were the primary sources of the housing boom and bust in the United States. However, examining how changes in the pattern of international capital flows affected yields on U.S. assets helps provide a deeper understanding of the origins and dynamics of the crisis.
- Topic:
- Finance, Capital Flows, Securities, and Capital
- Political Geography:
- North America and United States of America
33. A Note on Mundell-Fleming and Developing Countries
- Author:
- John Weeks
- Publication Date:
- 03-2008
- Content Type:
- Working Paper
- Institution:
- School of Oriental and African Studies - University of London
- Abstract:
- This paper inspects the statement found in macroeconomic text books that under a flexible exchange rate regime with perfectly elastic capital flows monetary policy is effective and fiscal policy is not. The logical validity of the statement requires that the domestic price level effect of devaluation be ignored. The price level effect is noted in some textbooks, but not analysed. When it is subjected to a rigorous analysis, the interaction between exchange rate changes and domestic price level changes render the standard statement false. The logically correct statement would be, under a flexible exchange rate regime with perfectly elastic capital flows the effectiveness of monetary policy depends on the values of the import share and the sum of the trade elasticities. Monetary policy will be more effective than fiscal policy if and only if the sum of the trade elasticities exceeds the import share. Inspection of data from developing countries indicates a low effectiveness of monetary policy under flexible exchange rates. In the more general case of less than perfectly elastic capital flows the conditions for monetary policy to be more effective than fiscal policy are even more restrictive. Use of empirical evidence on trade shares and interest rate differentials suggest that for most countries fiscal policy would prove more effective than monetary policy under a flexible exchange rate regime. In any case, the general theoretical assertion that monetary policy is more effective is incorrect.
- Topic:
- Monetary Policy, Developing World, Capital Flows, Macroeconomics, and Fiscal Policy
- Political Geography:
- Global Focus
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