Abstract
While the recent contraction of current account imbalances that followed the Global Financial Crisis is well documented, this paper analyzes the increasing divergence of net international investment positions in the post-crisis period. Decomposing the change in the net international investment position into capital flows and stock-flow adjustment, I find that the increasing stock imbalances are driven by the flows. However, stock-flow adjustments show a stabilizing pattern. Countries with the largest net foreign liabilities experienced the greatest valuation gains. Analyzing this effect by different asset classes shows that this stabilizing pattern was driven by a change in the value of portfolio equity. The pro-cyclical movement of domestic stock markets during the post-crisis period improved international risk sharing through foreign portfolio equity liabilities.
Highlights
In the last two decades, increasing financial integration has been of great importance in international macroeconomics
In the absence of a banking union and without independent monetary policy or a floating exchange rate, this mechanisms could represent an efficient way of risk sharing
We find that the increasing divergence is driven by remaining flow imbalances
Summary
In the last two decades, increasing financial integration has been of great importance in international macroeconomics. While flow imbalances decreased sharply in the post-crisis period, stock imbalances are still increasing (Figure 1, 2) This is seen as possible systemic risk, making large debtors vulnerable to changes in the market (International Monetary Fund, 2014b). We want to focus on the role of valuation effects of the net international investment position in the post-crisis period. We show that because stock markets moved in a pro-cyclical direction in the post-crisis period, countries with a lower output were able to generate relatively more valuation gains through their portfolio equity liabilities. The goal of this paper is to shed light on the dynamics behind the increasing imbalances of net international investment positions with a focus on the driving factors of the stabilising stock-flow adjustment.
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