Discussion Romain Ranciere (IMF) usual disclaimer applies

1. Capital Flows, Interest Rates and Precautionary Behaviour: a model of “global imbalances”Marcus Miller and Lei Zhang Discussion Romain Ranciere (IMF) usual disclaimer applies

2. A very interesting paper that proposes an integrated framework to jointly analyze two important questions: • Global Imbalances: large US Current Account Deficit and low interest rate • Precautionary Motive for Reserves Accumulation

3. a previous look on the link: • view of reserves accumulation as “mercantilist” policies (Dooley and al.) but • Aizenman-Lee (2006): more empirical support for precautionary motive view than for mercantilist view: a more liberal capital account increases international reserves.

4. Models of precautionary reserves • Caballero-Panageas (2005); Jeanne-Ranciere (2006) • small open “emerging” economy • no market for reserves assets; exogenous interest rate • Insurance against “sudden stops” • insurance domestic absorption/consumption against capital outflows [+ via balancesheet effect associated output losses)] • Crisis prevention / Crisis smoothing

5. Model of Global Imbalances and low-interest rates • Deterministic Models • e.g. Caballero and al. (growth differential; capital market impefections) • No risk; No demand for insurance • Demand for insurance + Capital Market Imperfection  Self-insurance

6. Miller-Zhang Model(s) • 2 “countries” (safe: US; risky: ROW); 2 period (risk in period 2) • risk: mean preserving output risk. GDP insurance (vs. SS insurance) • capital market (complete: insurance; incomplete: self-insurance) • risk-aversion (standard log utility; loss-avoidance) • intertemporal smoothing; crisis smoothing • general result: the risky country saves i.e. is net buyer of insurance securities (-> current account surplus in period 1). insurance premium ~ lower interest rate. • remark: the 2-period case allows to mask an assumption on hard credit constraint in bad times. (sudden stop literature: time-varying credit constraint)

7. Insurance • complete market: contigent claims. sell goods in good state for goods in bad states. • remark: if the insurer was risk-neutral (and competitive) no imbalance • the insurer is risk-averse-> modest imbalance.[<0.2% of GDP] • Self-insurance • incomplete market: accumulates risk-free asset government bonds • higher demand for US government bonds (lower interest rate) • but (still) modest imbalance [<0.5% of GDP] • why so little self-insurance? • cost/benefit of insurance: intertemporal distorsion vs. between-state distorsion. [increasing per unit cost of self-insurance]

8. Risk-Aversion Issues • log utility; constant relative risk-aversion~1. • Jeanne-Ranciere (2006) dramatic shift in demand for insurance between risk-aversion 1 and 4. [but more “crisis” insurance also means less “intertemporal smoothing”] • Natural extension: Epstein-Zin preferences separate preferences for intertemporal substitution and risk-aversion.

9. Loss Avoidance • downside risk is more costly than upside gains. • capture more broadly the “costs of crises”: political costs; distributional issues  worth developing. • alternative view: learning and overshooting misperception on the economic costs of crisis • RESULTS: combination of LA+severe output risk CAD 5% and possibility of negative real interest rate • Notice: here nominal = real one good. otherwise negative return  US depreciation. • US bonds is not a good insurance needs to buy a lot to get self-insurance “war chess”  crises are specially costly  ready to pay negative interest rate (cost of storage)

10. comparison with Jeanne-Ranciere (2006): insurance against sudden stop • Key difference: maturity transformation. the government accumulates reserves because it is less credit constrained than private sector [it can borrow long term while private sector borrows short-term] • cost of a crisis is capital outflows (11%) and output cost (6.5%) 17.5% reserves of 9.7% • crises are rare and severe events (pi=10%); risk-aversion is higher (2). At sigma=1 : zero reserves! • Cost of Reserves: term premium. 1.5% • Miller and Zhang: “excess” saving and insurance premium

11. remarks/questions • somehow unresolved tension: sudden stops and global imbalances. sudden stop typically occurs in the risky country with net capital inflows. who fears a sudden stop now (US or emerging?) • good simple model; possible extension towards calibration • break-even more the symmetry (growth differential; different shocks, different size paper by Imbs and Mauro (Pooling)) • real exchange rate depreciation • estimation of the parameters (->time-varying parameter) • OLG /simulation. • global temporary phenomenon (temporary buildup...): yes and no: probability of sudden stop increases with financial openness • US big insurer? can the insurer fail? risk-less or just less-risky US securities?