Financial Integration and the Wealth Effect of Exchange Rate Fluctuations

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractA growing body of research emphasizes the direct impact of exchange rate movements on the value of U.S. foreign assets. Because a substantial amount of U.S. assets are denominated in foreign currencies, a depreciation of the dollar leads to large capital gains. First, we present a detailed decomposition of the U.S. balance sheet, which exhibits substantial leverage in terms of currencies and across asset categories. The United States holds 50 percent of GDP in foreign-currency assets and is long in FDI (foreign direct investment) and equity positions and short in debt and banking positions. Then, we incorporate these features of international financial integration in a simple general equilibrium model and analyze how they affect the international transmission of monetary shocks. We find that financial integration is a central component of the model, with the valuation gains from an exchange rate depreciation leading to a welfare effect that is at least as large as that stemming from nominal rigidities alone but possibly much larger. We characterize how interdependence is affected by the composition of the portfolio across asset categories and how structural features of the model interact with financial integration.

Are valuation effects desirable from a global perspective?

“…Studies as Gourinchas and Rey (in press), Higgins et al (2005), Lane and Milesi-Ferretti (2004, in press-a), Tille (2003Tille ( , 2005 have documented that the composition of foreign assets and liabilities of the US economy is quite diversified ranging from bonds, equities to FDI. Moreover an important characteristic of the current composition is that the assets are mostly denominated in foreign currency while liabilities are mostly denominated in US dollars.…”

“…Moreover an important characteristic of the current composition is that the assets are mostly denominated in foreign currency while liabilities are mostly denominated in US dollars. In particular, as discussed in Tille (2005), the US economy is an overall net lender in securities denominated in foreign currency and borrower in dollardenominated securities. In our exercise, we assume that all these positions are made by bonds and in particular that the assets coincide with holdings of bonds denominated in foreign currency while the liabilities coincide with issuing bonds denominated in domestic currency.…”

“…In our exercise, we assume that all these positions are made by bonds and in particular that the assets coincide with holdings of bonds denominated in foreign currency while the liabilities coincide with issuing bonds denominated in domestic currency. To calibrate the steady state of the model, we refer to Tille (2005) for the US portfolio positions in the year 2004. In particular, the US net foreign asset position in that year is negative and equal to −22% of the GDP.…”

“…Studies as Gourinchas and Rey (2005, in press), Lane and Milesi-Ferretti (2004, in press-a,b) and Tille (2003Tille ( , 2005, have documented that in the recent experience of the US economy valuation effects have accounted for a large fraction of the changes in the international investment position of the country and have concluded that a depreciation of the US dollar can ease the real adjustment needed to reduce the external imbalances. 3 As pointed out by Obstfeld (2004), a theory in which financial adjustments and in particular exchange rate movements are important in determining the frontier of the feasible allocation of quantities and relative prices can raise the tempting argument that exchange rates adjust to sustain any real allocation achieved.…”

“…7 There has been a recent interest on the analysis of valuation effects from the view of micro-founded models. Tille (2005) presents a richer structure of financial markets, but in which the only focus is on monetary shocks and on how valuation effects affect their transmission mechanisms. Kollman (2003) studies the welfare effects of alternative, but sub-optimal, monetary policy regimes in a quantitative business cycle model of a two-country world.…”