This paper makes a case that the global imbalances of the 2000s and the recent global financial crisis are intimately connected. Both have their origins in economic policies followed in a number of countries in the 2000s and in distortions that influenced the transmission of these policies through U.S. and ultimately through global financial markets. In the U.S., the interaction among the Fed’s monetary stance, global real interest rates, credit market distortions, and financial innovation created the toxic mix of conditions making the U.S. the epicenter of the global financial crisis. Outside the U.S., exchange rate and other economic policies followed by emerging markets such as China contributed to the United States’ ability to borrow cheaply abroad and thereby finance its unsustainable housing bubble. *University of California, Berkeley, and Harvard University. Paper prepared for the Federal Reserve Bank of San Francisco Asia Economic Policy Conference, Santa Barbara, CA, October 18-20, 2009. Conference participants and especially discussant Ricardo Caballero offered helpful comments. We thank Alexandra Altman and Matteo Maggiori for outstanding research assistance. Financial support was provided by the Coleman Fung Risk Management Center at UC Berkeley and CEPREMAP.
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