This paper analyzes competing interpretations for the large increases in the hoarding of international reserves by developing countries. While the first phase of the rapid hoarding of reserves in the aftermath of the East Asian crisis has been dominated by self insurance against exposure to foreign shocks, the self insurance motive falls short of explaining the hoarding in Asia in the 2000s. These developments may be a symptom of an emerging new global financial architecture, which is manifested in the proliferation of decentralized and less cooperative arrangements. The emerging financial configuration of developing countries in the aftermath of the 1990s crises has been growing managed exchange rate flexibility, greater monetary independence, and deeper financial integration. Hoarding international reserves is a key ingredient enhancing the stability of this emerging configuration. While not a panacea, international reserves help by providing self insurance against sudden stops; mitigating REER effects of TOT shocks; smoothing overtime the adjustment to shocks by allowing more persistent current account patterns; and possibly even export promotion, though this mercantilist use of reserves remains debatable due to possible coordination issues. Countries following an export oriented growth strategy may end up with competitive hoarding, akin to competitive devaluations. The sheer size of China, and its lower sterilization costs suggests that China may be the winner of a hoarding game. Hoarding international reserves may also be motivated by a desire to deal with vulnerability to internal and external instability, which is magnified by exposure of the banking system to non performing loans. Testing the self insurance and precautionary motives in the context of China may be challenged by a version of the "peso problem." Hoarding international reserves and sterilization have been complementing each other during the last ten years, as developing countries have increased the intensity of both margins.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
13277.
Length: Date of creation: Jul 2007 Date of revision: Handle: RePEc:nbr:nberwo:13277
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Find related papers by JEL classification: F02 - International Economics - - General - - - International Economic Order; Noneconomic International Organizations;; Economic Integration and Globalization: General F1 - International Economics - - Trade F15 - International Economics - - Trade - - - Economic Integration F31 - International Economics - - International Finance - - - Foreign Exchange F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
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Eswar S. Prasad & Raghuram G. Rajan & Arvind Subramanian, 2007.
"Foreign Capital and Economic Growth,"
NBER Working Papers
13619, National Bureau of Economic Research, Inc.
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