Valuation Effects with Transitory and Trend Output Shocks

Abstract

This paper investigates the role of valuation effects on a country's net foreign asset position. It shows that following transitory output shocks, valuation effects are stabilizing; they counteract current account movements and mitigate the impact of the current account on a country's net foreign assets. Following trend shocks, valuation effects are amplifying; they move in the same direction as the current account and reinforce the impact of the current account on net foreign assets. The results are illustrated by the external imbalances between the U.S. and other industrialized countries since the 1990s.