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

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  • Durdu, Ceyhun Bora
  • Mendoza, Enrique G.
  • Terrones, Marco E.

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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Bibliographic 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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Web page: http://www.elsevier.com/locate/devec

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

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  1. Joshua Aizenman & Jaewoo Lee, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," NBER Working Papers 11366, National Bureau of Economic Research, Inc.
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