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Foreign ownership of U.S. safe assets: good or bad?

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The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. This paper analyzes the welfare consequences of these fluctuations in international capital flows in a two-sector general equilibrium model with uninsurable idiosyncratic and aggregate risks. The model implies that the young benefit from a capital inflow due to lower interest rates, which reduce the costs of home ownership and of borrowing against higher expected future income. Middle-aged savers are hurt because they are crowded out of the safe bond market and exposed to greater systematic risk in equity and housing markets. Although they are partially compensated for this in equilibrium by higher risk premia, they still suffer from lower expected rates of return on their savings. By contrast, retired individuals, who are drawing down assets and who receive social security income that is least sensitive to the current aggregate state, benefit handsomely from the rise in asset values that accompanies a capital inflow. Under the "veil of ignorance," newborns gain from foreign purchases of the safe asset and would be willing to forgo up to 1% of lifetime consumption in order to avoid a large capital outflow.

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en

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http://eprints.lse.ac.uk/43129/

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