The Stability of Large External Imbalances: The Role of Returns Differentials
Were the U.S. to persistently earn substantially more on its foreign investments ("U.S. claims") than foreigners earn on their U.S. investments ("U.S. liabilities"), the likelihood that the current environment of sizeable global imbalances will evolve in a benign manner increases. However, utilizing data on the actual foreign equity and bond portfolios of U.S. investors and the U.S. equity and bond portfolios of foreign investors, we find that the returns differential of U.S. claims over U.S. liabilities is essentially zero. Ending our sample in 2005, the differential is positive, whereas through 2004 it is negative; in both cases the differential is statistically indecipherable from zero. Moreover, were it not for the poor timing of investors from developed countries, who tend to shift their U.S. portfolios toward (or away from) equities prior to the subsequent underperformance (or strong performance) of equities, the returns differential would be even lower. Thus, in the context of equity and bond portfolios we find no evidence that the U.S. can count on earning more on its claims than it pays on its liabilities.
This paper will also be circulated as Federal Reserve IFDP#894. The views in this paper are solely the responsibility of the author(s) and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. We thank for helpful comments Carol Bertaut, Ricardo Caballero, Charles Engel, Kristen Forbes, Gian-Maria Milesi-Ferretti, Cedric Tille, Charles Thomas, Ralph Tryon, Eric van Wincoop, Jon Wongswan, and seminar participants at the Dallas Fed. Warnock thanks the Darden School Foundation for its generous support. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
- By isolating composition, return, and timing effects, the researchers determine that essentially no positive differential exists for...