Vitaliy Strohush (Boston College)
Abstract:
One of the features of the world economy since the early 1980s has been the persistent accumulation of current account imbalances. This paper demonstrates that simultaneous changes in the volatility of uninsurable idiosyncratic risk across countries can explain the occurrence of such imbalances. I construct an international real business cycle model in which heterogeneous agents are not able to fully insure against aggregate and idiosyncratic shocks to labor earnings. First, I show that changes in idiosyncratic volatility can lead to much larger external imbalances than changes in aggregate volatility of the same magnitude. Second, I employ the Luxembourg Income Study dataset to measure changes in idiosyncratic risk for selected countries over the period 1980-2000, and use the results to calibrate the model. Under this approach, the model can quantitatively explain between 30 and 40 percent of the change in the U.S. net foreign asset position and comes close to explaining th! e change in Japan's net foreign asset position. The results are robust to different parameter values and model specifications.
Keywords: Business cycle volatility, idiosyncratic volatility, precautionary saving, global imbalances, net foreign asset position, current account, heterogeneous agent models
JEL Classification: F32, F34, F41