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Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism

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Author Info
Durdu, Ceyhun Bora
Mendoza, Enrique G.
Terrones, Marco E.

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Abstract

Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework in which precautionary foreign asset demand is driven by output variability, financial globalization, and Sudden Stop risk. In this framework, credit constraints produce endogenous Sudden Stops. We find that financial globalization and Sudden Stop risk can explain the surge in reserves but output variability cannot. These results hold using the intertemporal preferences of the Bewley-Aiyagari-Hugget precautionary savings model or the Uzawa-Epstein setup with endogenous impatience.

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Publisher Info
Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 89 (2009)
Issue (Month): 2 (July)
Pages: 194-209
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Handle: RePEc:eee:deveco:v:89:y:2009:i:2:p:194-209

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Related research
Keywords: Fisherian deflation Liability dollarization Financial globalization Credit constraints Precautionary saving New Mercantilism Sudden Stops;

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  1. Eswar S. Prasad & Raghuram Rajan, 2008. "A Pragmatic Approach to Capital Account Liberalization," NBER Working Papers 14051, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Jeanne, Olivier & Rancière, Romain, 2008. "The Optimal Level of International Reserves For Emerging Market Countries: A New Formula and Some Applications," CEPR Discussion Papers 6723, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  3. Andrea M. Maechler & Bas Berend Bakker & Christoph Duenwald & Piritta Sorsa & Andrew Tiffin, 2007. "Vulnerabilities in Emerging Southeastern Europe--How Much Cause for Concern?," IMF Working Papers 07/236, International Monetary Fund. [Downloadable!]
  4. Lane, Philip R. & Shambaugh, Jay C, 2007. "Financial Exchange Rates and International Currency Exposures," CEPR Discussion Papers 6473, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Herrmann, Sabine & Winkler, Adalbert, 2008. "Financial markets and the current account: emerging Europe versus emerging Asia," Discussion Paper Series 1: Economic Studies 2008,05, Deutsche Bundesbank, Research Centre. [Downloadable!]
  6. Arslan Razmi, 2009. "Bretton Woods II and the Emerging Economies: Lazarus, Phoenix, or Humpty Dumpty?," Working Papers 2009-02, University of Massachusetts Amherst, Department of Economics. [Downloadable!]
  7. Ceyhun Bora Durdu, 2007. "Quantitative implications of indexed bonds in small open economies," International Finance Discussion Papers 909, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  8. Michael B Devereux & Alan Sutherland, 2009. "A Portfolio Model of Capital Flows to Emerging Markets," Working Papers 082009, Hong Kong Institute for Monetary Research. [Downloadable!]
  9. Maria Strömqvist & Sunil Sharma & Woon Gyu Choi, 2007. "Capital Flows, Financial Integration, and International Reserve Holdings: The Recent Experience of Emerging Markets and Advanced Economies," IMF Working Papers 07/151, International Monetary Fund. [Downloadable!]
  10. Christopher D. Carroll & Olivier Jeanne, 2009. "A Tractable Model of Precautionary Reserves, Net Foreign Assets, or Sovereign Wealth Funds," Peterson Institute Working Paper Series WP09-10, Peterson Institute for International Economics. [Downloadable!]
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  11. Laura Alfaro & Fabio Kanczuk, 2007. "Optimal Reserve Management and Sovereign Debt," NBER Working Papers 13216, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Marta Ruiz-Arranz & Milan Zavadjil, 2008. "Are Emerging Asia’s Reserves Really Too High?," IMF Working Papers 08/192, International Monetary Fund. [Downloadable!]
  13. Ceyhun Bora Durdu & Serdar Sayan, 2008. "Emerging market business cycles with remittance fluctuations," International Finance Discussion Papers 946, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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