In this paper we connect the events of the last twelve months, "The Panic of 2008" as it has been called, to the demand for international reserves. In previous work, we have shown that international reserve demand can be rationalized by a central bank's desire to backstop the broad money supply to avert the possibility of an internal/external double drain (a bank run combined with capital flight). Thus, simply looking at trade or short-term debt as motivations for reserve holdings is insufficient; one must also consider the size of the banking system (M2). Here, we show that a country's reserve holdings just before the current crisis, relative to their predicted holdings based on these financial motives, can significantly predict exchange rate movements of both emerging and advanced countries in 2008. Countries with large war chests did not depreciate -- and some appreciated. Meanwhile, those who held insufficient reserves based on our metric were likely to depreciate. Current account balances and short-term debt levels are not statistically significant predictors of depreciation once reserve levels are taken into account. Our model's typically high predicted reserve levels provide important context for the unprecedented U.S. dollar swap lines recently provided to many countries by the Federal Reserve.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
14826.
Length: Date of creation: Mar 2009 Date of revision: Handle: RePEc:nbr:nberwo:14826
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Find related papers by JEL classification: E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements F31 - International Economics - - International Finance - - - Foreign Exchange F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission O24 - Economic Development, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy
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