1. Bernanke “The Global Savings Glut and the U.S. Current Account Deficit” (2005) Vaughan / Economics 639 Fall 2015 1

2. Research Question Why was U.S. current account deficit so large? – Related question: Why was U.S. savings rate so low? Note: – Current Account = Exports - Imports – U.S. Net Foreign Borrowing = U.S. Current Account Deficit 2

3. World Savings Glut Story Developing world moved from net user to net supplier of funds in international capital markets in late 1990s/early 2000s, largely in response to financial crises. Savings flowed into the U.S., to take advantage of innovation/rising productivity (also because of sophistication of U.S. financial markets and special role of dollar as reserve currency). – At first, this inflow fueled an increase in equity prices (1996-2000). – After stock market correction (post-2000), inflow pushed down real interest rates down, which in turn boosted housing demand (and housing). 3

4. World Savings Glut Story Specific Mechanism Inflow of World Saving into U.S. led to: ↑ Demand for U.S. financial assets → ↑ Price of Dollar ↑ Price of Dollar → ↑ Imports, ↓ Exports [Current Account Deficit ↑ ] ↑ U.S. Household Wealth (higher stock/house prices) → ↑ Consumption, ↓ Saving (also fueled import demand and contributed to current-account deficit) 4

5. Ingredients in Housing Bubble Roberts: Households wanted to gamble with other people’s money. Kling: Basle made mortgage-related securities attractive. Taylor: Fed kept U.S. interest rates artificially low, making housing an attractive investment after break in equity market. Bernanke: World savings glut pushed interest rates to record low levels in U.S. 5 This time is different?

6. Reinhart & Rogoff: Predictors of Financial Crises Surge in Capital Inflows Note U.S. current account (capital inflow) was significantly larger. 6