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Liquidity Risk Aversion, Debt Maturity, and Current Account Surpluses: A Theory and Evidence from East Asia

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  • Shin-ichi Fukuda

    (Faculty of Economics, University of Tokyo)

  • Yoshifumi Kon

    (Graduate School of Economics, University of Tokyo)

Abstract

After a series of crises, many developing countries came to recognize that reducing liquidity risk is an important self-protection. However, they have alternative strategies for the self-protection. The purpose of this paper is to show that macroeconomic impacts might be very different depending on which strategy developing countries will take. In the first part, we investigate what macroeconomic impacts an increased aversion to liquidity risk can have in a simple open economy model. When the government keeps foreign reserves constant, an increased aversion to liquidity risk reduces liquid debt and increases illiquid debt. However, its macroeconomic impacts are not large, causing only small current account surpluses. In contrast, when the government responds to the shock, the changed aversion increases foreign reserves and may lead to a rise of liquidity debt. In particular, under some reasonable parameter set, it causes large macroeconomic impacts, including significant current account surpluses. In the second part, we provide several empirical supports to the implications. In particular, we explore how foreign debt maturity structures changed in East Asia. We find that many East Asian economies reduced short-term borrowings temporarily after the crisis but increased short-term borrowings in the early 2000s. Since short-term debt is liquid debt, the instantaneous change after the crisis is consistent with the case where only private agents responded to increased aversion to liquidity risk. However, accompanied by substantial rises in foreign exchange reserves, the change in the early 2000s is consistent with the case where the government also started to respond. We discuss that our results have important implications for the recent deterioration in the U.S. current account.

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Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-489.

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Length: 31 pages
Date of creation: Apr 2007
Date of revision:
Handle: RePEc:tky:fseres:2007cf489

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  1. Hamid Faruqee & Douglas Laxton & Dirk Muir & Paolo Pesenti, 2005. "Smooth landing or crash? model based scenarios of global current account rebalancing," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
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  3. Christopher Erceg & Luca Guerrieri & Christopher Gust, 2006. "Trade adjustment and the composition of trade," International Finance Discussion Papers 859, Board of Governors of the Federal Reserve System (U.S.).
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  5. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
  6. Jeffrey Frankel, 2005. "On the Renminbi: The Choice between Adjustment under a Fixed Exchange Rate and Adjustment under a Flexible Rate," NBER Working Papers 11274, National Bureau of Economic Research, Inc.
  7. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  8. Linda S. Goldberg & C├ędric Tille, 2006. "The International Role of the Dollar and Trade Balance Adjustment," NBER Working Papers 12495, National Bureau of Economic Research, Inc.
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