Monday, March 29, 2010

Another Nail in the Global Saving Glut Coffin

David Laibson and Johanna Mollerstrom have a new paper--see here for a shorter version--that further undermines the popular global saving glut theory (GSG). According to the GSG theory there was an increase in global savings beginning in the mid-to-late 1990s that originated in Asia and to a lesser extent in the oil-exporting countries. This surge in global savings found its way into the United States via large current account deficits that, in turn, created the asset bubbles of the past decade. Laibson and Mollerstrom argue the GSG theory has the causality backwards: the asset bubbles in the advanced economies came first and spurred consumers to go on a consumption binge. That consumption binge, in turn, was financed by savings from abroad. The smoking gun in their story is that had the foreign funding been truly exogenous then there would have been a far larger investment boom given the amount of foreign lending. Instead, there was a consumption boom which is more consistent with causality starting from an asset bubble. Their paper adds to their growing chorus of SGT skeptics including Menzie Chinn, Maurice Obstfeldt andKenneth Rogoff, Guillermo Calvo, and myself.

Interestingly, Laibson and Mollerstrom note that their story fails to answer two important issues:
There are many open questions that we have failed to address, but two stand out in our minds. First, our model takes the existence of the asset bubbles as given and does not explain their origins.


Second, our model does not explain why global interest rates fell between 2000 and 2003, and thereafter stayed at a relatively low level.
Well let me help Laibson and Mollertrom here. The actions of U.S. monetary policy can answer the first question and at least the first part of the second question for this period. As I have written before, this is easy to see given the Fed's monetary superpower status:
[T]he Fed is a global monetary hegemon. It holds the world's main reserve currency and many emerging markets are formally or informally pegged to dollar. Thus, its monetary policy is exported across the globe. This means that the other two monetary powers, the ECB and Japan, are mindful of U.S. monetary policy lest their currencies becomes too expensive relative to the dollar and all the other currencies pegged to the dollar. As as result, the Fed's monetary policy gets exported to some degree to Japan and the Euro area as well. From this perspective it is easy to understand how the Fed could have created a global liquidity glut in the early-to-mid 2000s since its policy rate was negative in real terms and below the growth rate of productivity (i.e. the fed funds rate was below the natural rate).

Given the Fed's role as a monetary hegemon the inevitability theme [i.e. the Fed had no choice but to accommodate the excess savings coming from Asia] underlying the saving glut view begins to look absurd. Moreover, the Fed's superpower status raises an interesting question: what would have happened to global liquidity had the Fed run a tighter monetary policy in the early-to-mid 2000s? There would have been less need for the dollar bloc countries to buy up dollars and, in turn, fewer dollar-denominated assets. As a result, less savings would have flowed from the dollar block countries to the United States. In short, some of the saving glut would have disappeared.
In short, the Fed set global monetary conditions at the time and pushed global short-term rates below their neutral level which, in turn, started the asset booms. Of course, financial innovations and credit abuses also played a role and may explain the persistence of the low global interest rates. I think my monetary superpower hypothesis fits nicely with the Laibson and Mollertrom story. One more nail in the saving glut coffin.

P.S. In case you are wondering, here is evidence the Fed kept the federal funds rate below the neutral rate during the early-to-mid 2000s (source). Here is more formal evidence from the ECB.


  1. Had the Fed not expanded the money supply so rapidly, the entry of so many ex-communist country workers into the global labor market -- especially the Chinese, post their devaluation of the yuan from 5.7 to 8.2 to the dollar -- would have pushed prices down and so pressured wages worldwide that we'd have gone into a deflationary bust even earlier (but with less debt). By expanding the money supply so rapidly, the Fed enabled the US workers whose manufacturing jobs were being eliminated to find work in home construction and distribution of the imported goods. Thus it provided the money to pay for the imports, which US workers otherwise wouldn't have been able to buy because they weren't able to sell anything to the exporting countries. As China, Japan and the other Asian nations had pegged their exchange rates at level such that buying US goods with their dollar earnings made no sense, the only thing they could do with the dollars was to lend them back to us, completing the circle and generating the appearance of a global savings glut.

    It was really a US liquidity glut combined with a global mercantilist vendor financing fraud glut.

  2. David,
    I reject the global savings glut hypothesis as well. And I accept that the Fed has the power to influence global interest rates. However I think Bernanke, courtesy of the IMF, has provided ample statistical evidence that monetary policy has little to do with the global asset bubbles.

    One can even point to particular cases that raise doubts that monetary policy played a role. Australia had a bubble and Germany did not for example although by a Taylor Rule measure Australia had a relatively tight monetary policy while Germany's was relatively loose.

    I think a better avenue of approach is "structural". Australia and Germany both had demand and supply side factors at work. Australia heavily subsidizes first time home owners and has draconian local restrictions on development. Germany has strict mortgage regulations and on the other hand has "right to build" laws in its constitution.

    And in the US, timing is a clue. Based on Shiller's real housing price index the national bubble started to inflate after 1997. What happened in 1997? The Taxpayer Relief Act greatly expanded real estate capital gains exclusions and made it possible for second homes to enjoy the same tax preferences as primary homes for the first time ever. And regional development regulations and other factors determined where the bubbles inflated (e.g. California vs. Texas).

    I really was excited by Mollerstrom's paper. I think we're gradually getting closer to acknowledging the correct explanation: bubbles attracted savings and not a savings glut that caused the bubbles. Now we need to come to some kind of consensus on what caused the bubbles.

  3. Mark:

    I do not want to argue monetary policy is everything here, but it seems highly important given the global nature of the housing boom. The BIS for years have been making the same point. Also, have you read the Obstfeld and Rogoff paper above? It makes a similar arguement. Finally, take a look at this OECD Paper. It makes the case for monetary policy interacting with rapid financial innovation as a key factor.

  4. David,

    Well, likewise I don't want to argue that monetary policy is absolutely nothing here.

    The evidence I'm thinking about was printed in last years's IMF World Economic Outlook (See figure 3.13):

    This seems to contradict the OECD results, so at best I would say the evidence on the importance of monetary policy from the cross- country regressions is mixed.

    Without having carefully read the OECD study I'm curious why they reach such different results. But I notice that the sample size for the housing price appreciation vs Taylor residual regression in the IMF study is much larger.