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Crowding out redefined: the role of reserve accumulation

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  • Reinhart, Carmen M.

    (Harvard University)

  • Tashiro, Takeshi

    (Harvard University)

Abstract

It is well understood that investment serves as a shock absorber at the time of crisis. The duration of the drag on investment, however, is perplexing. For the nine Asian economies we focus on in this study, average investment/GDP is about 6 percentage points lower during 1998-2012 than its average level in the decade before the crisis; if China and India are excluded, the estimated decline exceeds 9 percent. We document how in the wake of crisis home bias in finance usually increases markedly as public and private sectors look inward when external financing becomes prohibitively costly, altogether impossible, or just plain undesirable from a financial stability perspective. Also, previous studies have not made a connection between the sustained reserve accumulation and the persistent and significantly lower levels of investment in the region. Put differently, reserve accumulation involves an official institution (i.e., the central bank) funneling domestic saving abroad and thus competing with domestic borrowers in the market for loanable funds. We suggest a broader definition of crowding out, driven importantly by increased home bias in finance and by official capital outflows. We present evidence from Asia to support this interpretation.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2013)
Issue (Month): Nov ()
Pages: 1-43

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Handle: RePEc:fip:fedfpr:00008

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  1. Carmen M. Reinhart & M. Belen Sbrancia, 2011. "The Liquidation of Government Debt," BIS Working Papers 363, Bank for International Settlements.
  2. Prema-chandra Athukorala, 2010. "Malaysian Economy in Three Crises," Departmental Working Papers 2010-12, The Australian National University, Arndt-Corden Department of Economics.
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  17. Nicholas R. Lardy, 2012. "Sustaining China's Economic Growth after the Global Financial Crisis," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 6260, July.
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  20. M S Mohanty & Philip Turner, 2006. "Foreign exchange reserve accumulation in emerging markets: what are the domestic implications?," BIS Quarterly Review, Bank for International Settlements, September.
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