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Currency crises: can high reserves offset vulnerable fundamentals?

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  • Jie Li
  • Alice Ouyang

Abstract

First generation crisis models suggest that the size of international reserves affects only the timing of a crisis while second generation models imply that higher reserves can reduce the probability of a crisis. First in the literature, this article suggests the 'rolling probit model' to successfully demonstrate that high reserves can be effective in offsetting vulnerable fundamentals in a vulnerable zone. The more vulnerable fundamentals in the vulnerable zone require higher levels of international reserves to reduce the probability of a crisis. If the fundamentals are sufficiently bad, the level of needed reserves may be explosive, which makes a crisis unavoidable. Unlike the arbitrary proposals of reserve adequacy measures in current literature, this article also sheds light on such measures based on the relationship between vulnerable fundamentals and high reserves.

Suggested Citation

  • Jie Li & Alice Ouyang, 2011. "Currency crises: can high reserves offset vulnerable fundamentals?," Applied Economics, Taylor & Francis Journals, vol. 43(16), pages 2055-2069.
  • Handle: RePEc:taf:applec:v:43:y:2011:i:16:p:2055-2069
    DOI: 10.1080/00036840902984399
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    References listed on IDEAS

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    1. Eichengreen, Barry & Rose, Andrew & Wyplosz, Charles, 1996. " Contagious Currency Crises: First Tests," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 463-484, December.
    2. Reitz, Stefan & Taylor, Mark P., 2008. "The coordination channel of foreign exchange intervention: A nonlinear microstructural analysis," European Economic Review, Elsevier, vol. 52(1), pages 55-76, January.
    3. Jung Sik Kim & Jie Li & Ramkishen S. Rajan & Ozan Sula & Thomas D. Willett, 2007. "Reserve Adequacy In Asia Revisited: New Benchmarks Based On The Size And Composition Of Capital Flow," Korean Economic Review, Korean Economic Association, vol. 23, pages 131-158.
    4. Sarno,Lucio & Taylor,Mark P., 2003. "The Economics of Exchange Rates," Cambridge Books, Cambridge University Press, number 9780521485845, April.
    5. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-325, August.
    6. Li, Jie & Rajan, Ramkishen S., 2006. "Can High Reserves Offset Weak Fundamentals? A Simple Model of Precautionary Demand for Reserves," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 59(3), pages 317-328.
    7. Christian B. Mulder & Matthieu Bussière, 1999. "External Vulnerability in Emerging Market Economies; How High Liquidity Can Offset Weak Fundamentals and the Effects of Contagion," IMF Working Papers 99/88, International Monetary Fund.
    8. Aizenman, Joshua & Marion, Nancy, 2003. "The high demand for international reserves in the Far East: What is going on?," Journal of the Japanese and International Economies, Elsevier, vol. 17(3), pages 370-400, September.
    9. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
    10. Mody, Ashoka & Taylor, Mark P., 2007. "Regional vulnerability: The case of East Asia," Journal of International Money and Finance, Elsevier, vol. 26(8), pages 1292-1310, December.
    11. Mark P. Taylor, 2004. "Is Official Exchange Rate Intervention Effective?," Economica, London School of Economics and Political Science, vol. 71, pages 1-11, February.
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    Cited by:

    1. Abdilahi Ali & Katsushi S. Imai, 2015. "Editor's choice Crises, Economic Integration and Growth Collapses in African Countries," Journal of African Economies, Centre for the Study of African Economies (CSAE), vol. 24(4), pages 471-501.

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