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

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  • Marco E. Terrones

    (International Monetary Fund)

  • Enrique G. Mendoza

    (University of Maryland & NBER)

  • Ceyhun Bora Durdu

    (Federal Reserve Board)

Abstract

Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war-chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework in which precautionary foreign asset demand is driven by output variability, financial globalization, and Sudden Stop risk. In this framework, credit constraints produce endogenous Sudden Stops. We find that financial globalization and Sudden Stop risk can explain the surge in reserves but output variability cannot. These results hold using the intertemporal preferences of the Bewley-Aiyagari-Hugget precautionary savings model or the Uzawa-Epstein setup with endogenous impatience.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 56.

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Date of creation: 2008
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Handle: RePEc:red:sed008:56

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  1. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  2. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary demand for foreign assets in sudden stop economies: an assessment of the new mercantilism," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 911, Board of Governors of the Federal Reserve System (U.S.).
  3. Jonathan David Ostry & Carmen Reinhart, 1991. "Private Saving and Terms of Trade Shocks," IMF Working Papers, International Monetary Fund 91/100, International Monetary Fund.
  4. Ceyhun Bora Durdu, 2007. "Quantitative Implications of Indexed Bonds in Small Open Economies," 2007 Meeting Papers, Society for Economic Dynamics 482, Society for Economic Dynamics.
  5. Enrique G. Mendoza, 2006. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," IMF Working Papers, International Monetary Fund 06/88, International Monetary Fund.
  6. Aizenman, Joshua & LEE, JAEWOO, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," Santa Cruz Department of Economics, Working Paper Series qt2tn4w8x6, Department of Economics, UC Santa Cruz.
  7. Jeffrey A. Frankel & Eduardo A. Cavallo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, Or Less? Using Gravity to Establish Causality," NBER Working Papers 10957, National Bureau of Economic Research, Inc.
  8. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," Research Department Publications, Inter-American Development Bank, Research Department 4367, Inter-American Development Bank, Research Department.
  9. Martín Uribe, 2006. "Individual Versus Aggregate Collateral Constraints and the Overborrowing Syndrome," NBER Working Papers 12260, National Bureau of Economic Research, Inc.
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  11. Sebastian Edwards, 2007. "Capital Controls, Sudden Stops, and Current Account Reversals," NBER Chapters, National Bureau of Economic Research, Inc, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 73-120 National Bureau of Economic Research, Inc.
  12. Enrique G. Mendoza, 2006. "Lessons From the Debt-Deflation Theory of Sudden Stops," NBER Working Papers 11966, National Bureau of Economic Research, Inc.
  13. Michael Dooley & David Folkerts-Landau & Peter Garber, 2005. "An essay on the revived Bretton Woods system," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Feb.
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  16. Enrique G. Mendoza, 2002. "Credit, Prices, and Crashes: Business Cycles with a Sudden Stop," NBER Chapters, National Bureau of Economic Research, Inc, in: Preventing Currency Crises in Emerging Markets, pages 335-392 National Bureau of Economic Research, Inc.
  17. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 35-54, November.
  18. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, Elsevier, vol. 69(1), pages 6-36, June.
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  20. Epstein, Larry G., 1983. "Stationary cardinal utility and optimal growth under uncertainty," Journal of Economic Theory, Elsevier, Elsevier, vol. 31(1), pages 133-152, October.
  21. Enrique G. Mendoza, 2006. "Endogenous Sudden Stops in a Business Cycle Model with Collateral Constraints:A Fisherian Deflation of Tobin's Q," NBER Working Papers 12564, National Bureau of Economic Research, Inc.
  22. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(3), pages 659-84, August.
  23. Laura Alfaro & Fabio Kanczuk, 2007. "Optimal Reserve Management and Sovereign Debt," NBER Working Papers 13216, National Bureau of Economic Research, Inc.
  24. Romain Ranciere & Olivier Jeanne, 2006. "The Optimal Level of International Reserves for Emerging Market Countries," IMF Working Papers, International Monetary Fund 06/229, International Monetary Fund.
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  26. C. Bora Durdu & Enrique G. Mendoza & Marco Terrones, 2007. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism: Working Paper 2007-10," Working Papers, Congressional Budget Office 18952, Congressional Budget Office.
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