Winners and losers from reducing global imbalances

We analyze the welfare effects of various policies aimed at global rebalancing --- the elimination of persistent current account surpluses and deficits, and/or elimination of large positive and negative net foreign asset positions. Specifically, we study how these policies will affect the welfare of different groups of households, as well as overall wealth inequality within both debtor and creditor countries. We use a two-country version of a workhorse heterogeneous agents framework of Aiyagari (1994), calibrated to the U.S. (largest debtor) and a composite of its trading partners, the Rest of the World (ROW). Our results show that, relative to full financial integration, policies that reduce global imbalances via an increase in U.S. savings rates will lower global interest rates, increase capital-output ratio and total output in both countries. They will improve welfare of the poorest households and reduce wealth inequality in both countries. Conversely, policies that operate via a decrease in ROW's savings will raise global interest rates, reduce the capital-output ratio and total output in both countries. The rise in interest rates will reduce the welfare of the poor households, even though the overall wealth inequality will decline.