Do Differences in Financial Development Explain the Global Pattern of Current Account Imbalances?

74 Pages Posted: 3 Apr 2008

See all articles by Joseph W. Gruber

Joseph W. Gruber

Federal Reserve Board - Division of International Finance

Steven B. Kamin

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2008

Abstract

This paper addresses the popular view that differences in financial development explain the pattern of global current account imbalances. One strain of thinking explains the net flow of capital from developing to industrial economies on the basis of the industrial economies' more advanced financial systems and correspondingly more attractive assets. A related view addresses why the United States has attracted the lion's share of capital flows from developing to industrial economies; it stresses the exceptional depth, breadth, and safety of U.S. financial markets.

In this paper we empirically test these hypotheses. Building on Chinn and Prasad (2003) and Gruber and Kamin (2007), we assess econometrically whether different measures of financial development explain the net flow of capital from developing to industrial economies, as well as the concentration of those flows toward the United States. We also assess whether differences in asset returns, an alternative measure of the attractiveness of financial assets, can explain the international pattern of capital flows.

We find little evidence that differences in financial development help to explain the global pattern of current account imbalances. The measures of financial development generally do not explain either the net flow of capital from developing to industrial economies or, more specifically, the large U.S. current account deficits. Lower bond yields have been generally associated with lower current account balances (e.g., larger deficits) in industrial countries. However, U.S. bond yields have not been significantly lower than in other industrial economies, nor have expected equity earnings yields. This suggests, contrary to conventional wisdom, that U.S. financial assets have not been demonstrably more attractive than those of other industrial economies, and hence cannot explain the large U.S. deficit.

Finally, we consider the alternative but related hypothesis that spending in the United States was uniquely responsive to the lower cost of credit stemming from capital inflows from developing countries, thus accounting for the outsized U.S. deficit. However, we found this hypothesis also to be weak, as household saving rates have declined throughout the industrial economies, not just in the United States.

Keywords: Capital flows, bond yields, current account

JEL Classification: F21, F32

Suggested Citation

Gruber, Joseph W. and Kamin, Steven B., Do Differences in Financial Development Explain the Global Pattern of Current Account Imbalances? (March 1, 2008). FRB International Finance Discussion Paper No. 923. Available at SSRN: https://ssrn.com/abstract=1115844 or http://dx.doi.org/10.2139/ssrn.1115844

Joseph W. Gruber (Contact Author)

Federal Reserve Board - Division of International Finance ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

Steven B. Kamin

Board of Governors of the Federal Reserve System ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-3339 (Phone)
202-736-5638 (Fax)

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