Monday, October 6, 2008

Global Liquidity Glut or Global Saving Glut?

I have argued here many times that the "liquidity glut" view of the global economic imbalances has as much merit as the "saving glut view". Many prominent observers, however, completely ignore the "liquidity glut" view and only buy into the "saving glut" view (or a variant of it--the "investment drought view"), even when it puts them in an awkward position. Fortunately, there is now a paper by Thierry Bracke and Michael Fidora of the ECB that puts these competing views to a test. Here is the abstract from their paper:
Global Liquidity Glut or Global Saving Glut? A Structural VAR Approach
Since the late-1990s, the global economy is characterised by historically low risk premia and an unprecedented widening of external imbalances. This paper explores to what extent these two global trends can be understood as a reaction to three structural shocks in different regions of the global economy: (i) monetary shocks (“excess liquidity” hypothesis), (ii) preference shocks (“savings glut” hypothesis), and (iii) investment shocks (“investment drought” hypothesis). In order to uniquely identify these shocks in an integrated framework, we estimate structural VARs for the two main regions with widening imbalances, the United States and emerging Asia, using sign restrictions that are compatible with standard New Keynesian and Real Business Cycle models. Our results show that monetary shocks potentially explain the largest part of the variation in imbalances and financial market prices. We find that savings shocks and investment shocks explain less of the variation. Hence, a “liquidity glut” may have been a more important driver of real and financial imbalances in the US and emerging Asia than a “savings glut”.
Bottome line: monetary policy via the global liquidity glut matters for global economic imbalances.


  1. Just wanted to say thanks for posting this paper. I'm an instructor of economics at a small university and find that the "savings glut" is the answer most often given as the "step 1" part of the answer to "how did we get here?"
    It's nice to get some empirical evidence of a different hypothesis.
    Seems to go hand-in-hand with the increasing realization that this crisis isn't a liquidity problem but a capital problem and that any rescue plans should address that rather than focus on liquidity. Thanks.

  2. ZIRP is here brother Beckworth.

    The Fed busted up it's balance sheet by $600 billion in 60 days. And the Treasury wants to add another $700 billion to the conflagration.

    Post WW2 macroeconomic textbooks should be burned on top of all econometricians.