IDEAS home Printed from
MyIDEAS: Login to save this article or follow this journal

Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism

  • Durdu, Ceyhun Bora
  • Mendoza, Enrique G.
  • Terrones, Marco E.

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.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 89 (2009)
Issue (Month): 2 (July)
Pages: 194-209

in new window

Handle: RePEc:eee:deveco:v:89:y:2009:i:2:p:194-209
Contact details of provider: Web page:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Enrique G. Mendoza, 2005. "Real Exchange Rate Volatility and the Price of Nontradables in Sudden-Stop-Prone Economies," NBER Working Papers 11691, National Bureau of Economic Research, Inc.
  2. Alfaro, Laura & Kanczuk, Fabio, 2009. "Optimal reserve management and sovereign debt," Journal of International Economics, Elsevier, vol. 77(1), pages 23-36, February.
  3. Ceyhun Bora Durdu, 2007. "Quantitative Implications of Indexed Bonds in Small Open Economies," 2007 Meeting Papers 482, Society for Economic Dynamics.
  4. 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 911, Board of Governors of the Federal Reserve System (U.S.).
  5. Joshua Aizenman & Jaewoo Lee, 2007. "International Reserves: Precautionary Versus Mercantilist Views, Theory and Evidence," Open Economies Review, Springer, vol. 18(2), pages 191-214, April.
  6. Sunil Sharma & Woon Gyu Choi & Maria Strömqvist, 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.
  7. Cavallo, Eduardo A. & Frankel, Jeffrey A., 2008. "Does openness to trade make countries more vulnerable to sudden stops, or less? Using gravity to establish causality," Journal of International Money and Finance, Elsevier, vol. 27(8), pages 1430-1452, December.
  8. Martin Uribe & Vivian Z. Yue, 2003. "Country Spreads and Emerging Countries: Who Drives Whom?," NBER Working Papers 10018, National Bureau of Economic Research, Inc.
  9. Enrique G. Mendoza, 2002. "Credit, Prices, and Crashes: Business Cycles with a Sudden Stop," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 335-392 National Bureau of Economic Research, Inc.
  10. Sebastian Edwards, 2007. "Capital Controls, Sudden Stops, and Current Account Reversals," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 73-120 National Bureau of Economic Research, Inc.
  11. Romain Ranciere & Olivier Jeanne, 2006. "The Optimal Level of International Reserves for Emerging Market Countries: Formulas and Applications," IMF Working Papers 06/229, International Monetary Fund.
  12. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2003. "An Essay on the Revived Bretton Woods System," NBER Working Papers 9971, National Bureau of Economic Research, Inc.
  13. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  14. Jonathan D. Ostry & Carmen M. Reinhart, 1992. "Private Saving and Terms of Trade Shocks: Evidence from Developing Countries," IMF Staff Papers, Palgrave Macmillan, vol. 39(3), pages 495-517, September.
  15. Marco Terrones & Eswar Prasad & M. Ayhan Kose, 2003. "Financial Integration and Macroeconomic Volatility," IMF Working Papers 03/50, International Monetary Fund.
  16. Ricardo J. Caballero & Stavros Panageas, 2003. "Hedging Sudden Stops and Precautionary Contractions," NBER Working Papers 9778, National Bureau of Economic Research, Inc.
  17. Guillermo A. Calvo & Alejandro Izquierdo & Luis-Fernando Mejia, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," NBER Working Papers 10520, National Bureau of Economic Research, Inc.
  18. 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.
  19. Mendoza, Enrique G & Quadrini, Vincenzo & Ríos-Rull, José-Víctor, 2007. "Financial Integration, Financial Deepness and Global Imbalances," CEPR Discussion Papers 6149, C.E.P.R. Discussion Papers.
  20. 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.
  21. Enrique G. Mendoza, 2006. "Lessons from the Debt-Deflation Theory of Sudden Stops," American Economic Review, American Economic Association, vol. 96(2), pages 411-416, May.
  22. 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 18952, Congressional Budget Office.
  23. Woon Gyu Choi & Sunil Sharma & Maria Str�mqvist, 2009. "Net Capital Flows, Financial Integration, and International Reserve Holdings: The Recent Experience of Emerging Markets and Advanced Economies," IMF Staff Papers, Palgrave Macmillan, vol. 56(3), pages 516-540, August.
  24. Epstein, Larry G., 1983. "Stationary cardinal utility and optimal growth under uncertainty," Journal of Economic Theory, Elsevier, vol. 31(1), pages 133-152, October.
  25. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  26. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
  27. Martín Uribe, 2006. "Individual Versus Aggregate Collateral Constraints and the Overborrowing Syndrome," NBER Working Papers 12260, National Bureau of Economic Research, Inc.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:eee:deveco:v:89:y:2009:i:2:p:194-209. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.