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Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism

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Author Info
Ceyhun Bora Durdu
Marco Terrones
Enrique G. Mendoza

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Abstract

Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops in the 1990s. The surge in foreign reserves since then is viewed as a New Merchantilism in which reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a framework in which precautionary savings affect foreign assets via business cycle volatility, financial globalization, and endogenous Sudden Stops. Our results show that financial globalization and Sudden Stop risk are plausible explanations of the surge in reserves but cyclical volatility, which has declined in the globalization period, is not.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/146.

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Length: 54 pages
Date of creation: 28 Jun 2007
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Handle: RePEc:imf:imfwpa:07/146

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Related research
Keywords: Working Paper ; Reserves accumulation ; Crisis prevention ; Financial crisis ; Deflation ; Deflation ; Dollarization ; Globalization ; Business cycles ; Credit ; Economic models ;

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  1. Prasad, Eswar & Rajan, Raghuram G., 2008. "A Pragmatic Approach to Capital Account Liberalization," IZA Discussion Papers 3475, Institute for the Study of Labor (IZA). [Downloadable!]
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  2. Philip R Lane & Jay C Shambaugh, 2007. "Financial exchange rates and international currency exposures," CGFS Papers chapters, in: Bank for International Settlements (ed.), Research on global financial stability: the use of BIS international financial statistics, volume 29, pages 90-127 Bank for International Settlements. [Downloadable!]
    Other versions:
  3. 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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  4. Laura Alfaro & Fabio Kanczuk, 2007. "Optimal Reserve Management and Sovereign Debt," NBER Working Papers 13216, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. 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!]
  6. 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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  7. Marta Ruiz-Arranz & Milan Zavadjil, 2008. "Are Emerging Asia’s Reserves Really Too High?," IMF Working Papers 08/192, International Monetary Fund. [Downloadable!]
  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. 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)
  10. 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!]
  11. 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!]
  12. 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!]
  13. 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!]
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