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Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies

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  • Aizenman, Joshua
  • Edwards, Sebastian
  • Riera-Crichton, Daniel

Abstract

We analyze the way in which Latin American countries have adjusted to commodityterms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degreeto which the active management of international reserves and exchange rates impacted thetransmission of international price shocks to real exchange rates. We find that active reservemanagement not only lowers the short-run impact of CTOT shocks significantly, but alsoaffects the long-run adjustment of REER, effectively lowering its volatility. We also show thatrelatively small increases in the average holdings of reserves by Latin American economies (tolevels still well below other emerging regions current averages) would provide a policy tool aseffective as a fixed exchange rate regime in insulating the economy from CTOT shocks.Reserve management could be an effective alternative to fiscal or currency policies forrelatively trade closed countries and economies with relatively poor institutions or highgovernment debt. Finally, we analyze the effects of active use of reserve accumulation aimedat smoothing REERs. The result support the view that “leaning against the wind†is potent, butmore effective when intervening to support weak currencies rather than intervening to slowdown the pace of real appreciation. The active reserve management reduces substantiallyREER volatility.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt2bq3246m.

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Date of creation: 10 Jan 2012
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Handle: RePEc:cdl:ucscec:qt2bq3246m

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Keywords: Social and Behavioral Sciences; Terms of trade; the real exchange rate; international reserves; commodity price shocks; volatility; exchange rate regime;

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References

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  1. Joshua Aizenman & Daniel Riera-Crichton, 2008. "Real Exchange Rate and International Reserves in an Era of Growing Financial and Trade Integration," The Review of Economics and Statistics, MIT Press, vol. 90(4), pages 812-815, November.
  2. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
  3. Rudiger Dornbusch, 1981. "Real Interest Rates, Home Goods, and Optimal External Borrowing," NBER Working Papers 0779, National Bureau of Economic Research, Inc.
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  5. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2003. "An Essay on the Revived Bretton Woods System," NBER Working Papers 9971, National Bureau of Economic Research, Inc.
  6. Aghion, Philippe & Bacchetta, Philippe & Ranciere, Romain & Rogoff, Kenneth S., 2009. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," Scholarly Articles 12490419, Harvard University Department of Economics.
  7. International Monetary Fund, 2009. "Commodity Terms of Trade," IMF Working Papers 09/205, International Monetary Fund.
  8. Joshua Aizenman & Nancy P. Marion, 2002. "The high demand for international reserves in the Far East: what's going on?," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  9. Yu-chin Chen & Kenneth Rogoff & Barbara Rossi, 2008. "Can Exchange Rates Forecast Commodity Prices?," Working Papers UWEC-2008-11-FC, University of Washington, Department of Economics, revised Oct 2009.
  10. Neary, Peter, 1988. "Determinants of the Equilibrium Real Exchange Rate," American Economic Review, American Economic Association, vol. 78(1), pages 210-15, March.
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  12. Robert P. Flood & Nancy P. Marion, 2002. "Holding International Reserves in an Era of High Capital Mobility," IMF Working Papers 02/62, International Monetary Fund.
  13. Jacob A. Frenkel & Boyan Jovanovic, 1978. "On Transactions and Precautionary Demand For Money," NBER Working Papers 0288, National Bureau of Economic Research, Inc.
  14. Ricardo Hausmann & Ugo Panizza & Roberto Rigobon, 2004. "The Long-Run Volatility Puzzle of the Real Exchange Rate," NBER Working Papers 10751, National Bureau of Economic Research, Inc.
  15. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June.
  16. Joshua Aizenman & Daniel Riera-Crichton, 2006. "Real Exchange Rate and International Reserves in the Era of Growing Financial and Trade Integration," NBER Working Papers 12363, National Bureau of Economic Research, Inc.
  17. Jose De Gregorio & Holger C. Wolf, 1994. "Terms of Trade, Productivity, and the Real Exchange Rate," NBER Working Papers 4807, National Bureau of Economic Research, Inc.
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Cited by:
  1. Titelman, Daniel & Vera, Cecilia & Carvallo, Pablo & Perez Caldentey, Esteban, 2012. "Un Fondo de Reservas Regional para América Latina
    [A Regional Reserve Fund for Latin America]
    ," MPRA Paper 42614, University Library of Munich, Germany.
  2. Cheung , Yin-Wong & Sengupta , Rajeswari, 2013. "Impact of exchange rate movements on exports: An analysis of Indian non-financial sector firms," BOFIT Discussion Papers 10/2013, Bank of Finland, Institute for Economies in Transition.
  3. Vincent Bodart & Bertrand Candelon & Jean-François Carpantier, 2013. "Real exchange rates, commodity prices and structural factors in developing countries," CREA Discussion Paper Series 13-09, Center for Research in Economic Analysis, University of Luxembourg.
  4. Virginie Coudert & Cécile Couharde & Valérie Mignon, 2014. "On the impact of oil price volatility on the real exchange rate–terms of trade nexus: Revisiting commodity currencies," EconomiX Working Papers 2014-3, University of Paris West - Nanterre la Défense, EconomiX.
  5. Steiner, Andreas, 2013. "The accumulation of foreign exchange by central banks: Fear of capital mobility?," Journal of Macroeconomics, Elsevier, vol. 38(PB), pages 409-427.
  6. Buetzer, Sascha & Habib, Maurizio Michael & Stracca, Livio, 2012. "Global exchange rate configurations: Do oil shocks matter?," Working Paper Series 1442, European Central Bank.
  7. Luis Felipe Céspedes & Andrés Velasco, 2012. "Macroeconomic Performance During Commodity Price Booms and Busts," NBER Working Papers 18569, National Bureau of Economic Research, Inc.
  8. Steiner, Andreas, 2013. "How central banks prepare for financial crises – An empirical analysis of the effects of crises and globalisation on international reserves," Journal of International Money and Finance, Elsevier, vol. 33(C), pages 208-234.
  9. Joshua Aizenman & Yothin Jinjarak & Donghyun Park, 2013. "Fundamentals and Sovereign Risk of Emerging Markets," NBER Working Papers 18963, National Bureau of Economic Research, Inc.
  10. Aizenman, Joshua & Dekle, Robert & Lothian, James R., 2012. "Overview of the special issue on “Policy Implications of and Lessons from the Global Financial Crisis”," Journal of International Money and Finance, Elsevier, vol. 31(8), pages 1971-1975.

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