Global Flight to Safety, Business Cycles, and the Dollar

Abstract

We estimate a two-country DSGE model with macroeconomic and financial data for the U.S. and the rest of the world. The model features time variation in agents’ preference for safe bonds with a global flight-to-safety (GFS) component biased toward dollar-denominated safe bonds. Our estimation produces two main findings. First, GFS shocks are the most important driver of international business cycles. Second, GFS shocks contribute to the resolution of exchange rate puzzles. Movements in the dollar are largely accounted for by the GFS and other fundamental shocks, whereas pure deviations from uncovered interest rate parity play a more limited role.