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Discussion of “Could capital gains smooth a current account rebalancing?” by Cavallo and Tille

Discussion of “Could capital gains smooth a current account rebalancing?” by Cavallo and Tille. Akito Matsumoto (IMF) This is my own view. What They Did?. scenario analysis of current account adjustment real side of the model – OR (2005) 3-region model Traded Goods – Non-Traded Goods

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Discussion of “Could capital gains smooth a current account rebalancing?” by Cavallo and Tille

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  1. Discussion of “Could capital gains smooth a current account rebalancing?” by Cavallo and Tille Akito Matsumoto (IMF) This is my own view.

  2. What They Did? • scenario analysis of current account adjustment • real side of the model – OR (2005) • 3-region model • Traded Goods – Non-Traded Goods • LOOP holds • GDP deflator targeting • endowment economy • no shocks • more “realistic” adjustment scenario • dynamic adjustment

  3. Dynamic Adjustment • heroic assumption • constant net asset position • this pins down the adjustment length • constant new portfolio allocation - p • simple and easy to understand • requires CA=V -> constant net asset position • gross position increases /not • “exorbitant privilege” /not • the US pays lower interest rate on its liability

  4. What Is Good About It? • using the current portfolio for initial condition • more realistic than mirror image model • focusing on valuation effect from the (real) exchange rate movement • simple model for policy circle

  5. Result • slow adjustment: half life of CA, RER 3 years. 10yrs for near “SS”. • almost same degree of adjustment as OR • with “exorbitant privilege” • in the LR, 30% real depreciations • in the LR, net interest income >0 as gross position grows. TB<0 • w/o “exorbitant privilege” • in the LR, 40% real depreciations • standard result TB>0, NI<0

  6. Is Slow Adjustment of RER Realistic?

  7. Is Depreciation Enough?

  8. One Suggestion Here • maybe too slow adjustment • Not enough RER change • sensitivity analysis in other parameter • q and h • elasticity among tradable/ btw. T and NT may help

  9. Questions About Their Scenario 1 • are Japanese investors so stupid? why do they invest their assets in the US if ru<rw • They might have been, but... • possible explanations for having US asset • Risk – Return trade-off? US asset is safe? • vehicle currency > need to hold dollar?

  10. Questions About Their Scenario 2 • why ru<rw ? • return on each asset group (bond, stock) was higher in the US than in Japan and Europe for the last 15 years • is it realistic for next ten years? • if “exorbitant privilege” is true among developed country, it is probably asset compositions rather than return discount • risk tolerance?

  11. What Drives Exchange Rate?

  12. What Do We Need? • probably emerging countries (or call Asia as emerging countries) to generate ru>rw and provide nice model; shocks • risks in Asia are high? • endogenous portfolio allocation with exogenous “r” • better to have endogenous “r” • Engel and Matsumoto (2006) Though our model is too simple in other dimensions • FX as an asset

  13. Conclusion • valuation effect is important • nice analysis for policy circle • but need more analysis on portfolio choice • remind me of the need to develop realistic DSGE model with international portfolio choice

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