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IFA DYNAMICS — Result In Brief

Project ID: 210584
Funded under: FP7-IDEAS-ERC
Country: United Kingdom

New insight into the determinants of foreign assets, trade balance and exchange rate

An EU-funded project developed new theories and data sets to understand the determinants of net and gross foreign assets, the trade balance and the exchange rate.
New insight into the determinants of foreign assets, trade balance and exchange rate
IFA DYNAMICS (Countries' external balance sheets, dynamics of international adjustment and capital flows) constructed a detailed data set of the United States external balance sheet at market value for the period 1952-2012. Strong evidence of a sizeable excess return of gross assets over gross liabilities was found.

The centre country (United States) of the international monetary system enjoys an exorbitant privilege, which significantly weakens its external constraint. In exchange, the country provides insurance to the rest of the world in times of global stress.

During the global financial crisis of 2007-2009, wealth transfers from the United States to other countries amounted to 19 % of the country's gross domestic product. Researchers built a database to show that countries benefited differently from these transfers, depending on their external balance sheet. Data showed that some countries made losses on their debt portfolios, depending on their exposure to toxic assets and the extent of dollar shortage.

The project assessed the growth and risk-sharing benefits of financial integration, developing a methodological concept of risky steady state. Researchers estimated the welfare gains of financial integration for emerging and advanced economies, allowing room for asymmetries in volatility, capital scarcity and size. The model can generate patterns of capital flows that are similar to global imbalances. In almost every case, welfare gains from financial integration were found to be small, even for volatile emerging market economies.

IFA DYNAMICS constructed a large database of international investments of equity funds at the stock level to study dynamic investment strategies. Managers adopt a rebalancing behaviour for their position, following valuation gains or losses on their portfolios, due to exchange rate risk or equity risk. This behaviour is important in order to assess the contribution of mutual funds to the overall stability of global financial markets.

Finally, project fellows have demonstrated that common world factor prices cover a very wide cross-section of risky assets, such as equities, corporate bonds and commodities. They found evidence of a global financial cycle in capital flows, asset prices and credit growth, regardless of the exchange rate adopted by countries.

Overall, the project suggests, through a VAR analysis, that the monetary policy in the United States is a determinant of the global financial cycle. It affects leverage of global banks, capital flows and credit growth in the international financial system. Therefore, to control monetary conditions on a national basis may require macroprudential policies and/or capital controls.

Related information


Assets, trade balance, exchange rate, IFA DYNAMICS, external balance sheets, capital flows
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