1. Introduction
The global integration of capital markets has been one of the biggest stories in the world economy in
recent decades. International asset trade offers several potential benefits. Countries can share risks via
international portfolio diversification; the efficient allocation of capital to the most productive
locations is promoted; and consumption can be smoothed across time periods in response to shifts in
macroeconomic fundamentals. While risk-sharing may be largely accomplished through gross
international asset trade, net capital flows will typically be required for the latter two functions.
With respect to net asset trade, the empirical literature initiated by Feldstein and Horioka
(1980) has focused on the evolution of current accounts across countries and through time,
highlighting the degree of co-movement between national saving and domestic investment. Another
branch of the literature has investigated whether net capital flows respond appropriately to cyclical
macroeconomic shocks, most prominently in the literature that has tested “present value” models of
the current account (see Obstfeld and Rogoff 1996).
In this paper, we instead turn our attention to the stocks of external assets and liabilities,
studying the long-term factors driving the evolution of countries’ net external positions. Our interest
in this subject, which has have received much less attention in the literature, is based on a number of
considerations. First, international macroeconomic theory suggests that a host of long-term
fundamentals can lead to countries becoming persistent international net creditors or international net
debtors. Such long-term factors can be missed if emphasis is exclusively placed on current account
imbalances, even using long spans of data: for instance, a country may run persistent current account
deficits but still be reducing its external liabilities relative to GDP. Second, if long-term factors are
important in determining net foreign asset positions, short-term flows cannot be properly understood
unless the constraints imposed by long-run equilibrium conditions are explicitly taken into account.
For example, the implications of a country’s current account deficit depend on whether it is moving
the country towards or away from its target long-run net foreign asset position.