Faced with income fluctuations, countries smooth their consumption by raising savings when income is high, and vice versa. How much of these savings do countries invest at home and abroad? In other words, what are the effects of fluctuations in savings on domestic investment and the current account? In the long run, we find that countries invest the marginal unit of savings in domestic and foreign assets in the same proportions as in their initial portfolio, so that the latter is remarkably

more »

... le. In the short run, we find that countries invest the marginal unit of savings mostly in foreign assets, and only gradually do they rebalance their portfolio back to its original composition. This means that countries not only try to smooth consumption, but also domestic investment. To achieve this, they use foreign assets as a buffer stock. __________________________________________________________________ * This paper has been prepared for the 2002 NBER Macroeconomics Annual. We are grateful to our discussants Fabrizio Perri and Eric van Wincoop as well as to the participants for their useful comments. The opinions expressed here are the authors', and do not necessarily reflect those of the World Bank, its executive directors, or the countries they represent.