Rhyme or Reason: What Explains the Easy Financing of the US Current Account Deficit?

This paper examines the roles of U.S. financial innovation, financial globalization, and the savings glut hypothesis in explaining the rise in U. S. external debt, first in a portfolio balance model, and then empirically. Perhaps surprisingly, financial deepening and falling home bias in industrialized countries explain a large share of external financing. The savings glut hypothesis (including difficult-to-track petrodollar recycling) and U.S. financial innovation also play a role, in part as a cause of declining home bias in industrialized countries. The latter underscores the importance of not looking at these factors in isolation, but rather as a constellation of forces that can be self-reinforcing. [JEL F32, F34, G11, G12, G15] IMF Staff Papers (2009) 56, 410-445. doi: 10.1057/imfsp.2009.11