25
significant for the 1980-98 period and the estimated point coefficient typically larger for the more
recent period. These findings are little affected by inclusion of the stock of public debt and the rate of
real exchange rate appreciation. Even stronger results are obtained when the net foreign asset position
is instrumented by the level of GDP per capita, public debt and demographic variables in columns
(5)-(8), suggesting that the relation is not being generated by reverse causality running from the real
interest differential on the net foreign asset position.
Figure 10 provides a scatter plot of average net foreign assets and real interest rates over the
period 1990-98, documenting a negative relation between these variables. Table 10 reports cross-
section regression results for the same period. In the cross-section, net foreign assets again have a
significant effect on the real interest rate differential across all specifications. For instance, the point
estimate of-1.07 in column (1) of panel B indicates that, all else equal, a country with an average net
foreign asset to exports ratio that is 50 percentage points above the sample mean enjoys a real interest
rate that is 53.5 basis points below the average real interest rate differential vis-à-vis the US. We note
also that the stock of public debt typically has a marginally significant positive impact on the real
interest differential rate (at the 10 percent level) but real exchange rate appreciation has no impact in
the cross-sectional specification.
The results in this section provide some suggestive evidence that net foreign asset positions
matter in determining real interest rate differentials, in line with the spirit of the portfolio balance
literature.39 In future work, it would be instructive to experiment with different asset classes and
maturities and explore alternative techniques for calculating expected inflation and the expected rate
of real appreciation. Moreover, it would be interesting to distinguish between different components of
the net foreign asset position (e.g. is it just net external debt that matters? / do portfolio equity
39 Bayoumi and Gagnon (1996) predict that a country’s net foreign asset position should be negatively
correlated with its (after-tax) real interest rate. In this case, our estimate of the portfolio balance effect will be
understated if a high real interest rate endogenously improves the net foreign asset position. We further note that
inflation and real interest rates are negatively correlated in the time series dimension of our data set but
positively correlated in the cross-section.