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Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies

  • Aizenman, Joshua
  • Edwards, Sebastian
  • Riera-Crichton, Daniel

We analyze the way in which Latin American countries have adjusted to commodityterms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degreeto which the active management of international reserves and exchange rates impacted thetransmission of international price shocks to real exchange rates. We find that active reservemanagement not only lowers the short-run impact of CTOT shocks significantly, but alsoaffects the long-run adjustment of REER, effectively lowering its volatility. We also show thatrelatively small increases in the average holdings of reserves by Latin American economies (tolevels still well below other emerging regions current averages) would provide a policy tool aseffective as a fixed exchange rate regime in insulating the economy from CTOT shocks.Reserve management could be an effective alternative to fiscal or currency policies forrelatively trade closed countries and economies with relatively poor institutions or highgovernment debt. Finally, we analyze the effects of active use of reserve accumulation aimedat smoothing REERs. The result support the view that “leaning against the wind†is potent, butmore effective when intervening to support weak currencies rather than intervening to slowdown the pace of real appreciation. The active reserve management reduces substantiallyREER volatility.

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Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt2bq3246m.

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Date of creation: 10 Jan 2012
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Handle: RePEc:cdl:ucscec:qt2bq3246m
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  1. Dani Rodrik, 1998. "Where Did All The Growth Go? External Shocks, Social Conflict, and Growth Collapses," NBER Working Papers 6350, National Bureau of Economic Research, Inc.
  2. Neary, J Peter, 1987. "Determinants of the Equilibrium Real Exchange Rate," CEPR Discussion Papers 209, C.E.P.R. Discussion Papers.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
  4. Yu-Chin Chen & Kenneth S. Rogoff & Barbara Rossi, 2010. "Can Exchange Rates Forecast Commodity Prices?," The Quarterly Journal of Economics, MIT Press, vol. 125(3), pages 1145-1194, August.
  5. Jose De Gregorio & Holger C. Wolf, 1994. "Terms of Trade, Productivity, and the Real Exchange Rate," Working Papers 94-19, New York University, Leonard N. Stern School of Business, Department of Economics.
  6. Dornbusch, Rudiger, 1983. "Real Interest Rates, Home Goods, and Optimal External Borrowing," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 141-53, February.
  7. Joshua Aizenman & Daniel Riera-Crichton, 2008. "Real Exchange Rate and International Reserves in an Era of Growing Financial and Trade Integration," The Review of Economics and Statistics, MIT Press, vol. 90(4), pages 812-815, November.
  8. Philippe Aghion & Philippe Bacchetta & Romain Ranciere & Kenneth Rogoff, 2006. "Exchange Rate Volatility and Productivity Growth: The Role of Financial Development," NBER Working Papers 12117, National Bureau of Economic Research, Inc.
  9. Joshua Aizenman & Nancy P. Marion, 2002. "The high demand for international reserves in the Far East: what's going on?," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
  10. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June.
  11. Frenkel, Jacob A & Jovanovic, Boyan, 1980. "On Transactions and Precautionary Demand for Money," The Quarterly Journal of Economics, MIT Press, vol. 95(1), pages 25-43, August.
  12. Joshua Aizenman & Daniel Riera-Crichton, 2006. "Real Exchange Rate and International Reserves in the Era of Growing Financial and Trade Integration," NBER Working Papers 12363, National Bureau of Economic Research, Inc.
  13. Knack, Stephen & Keefer, Philip, 1997. "Does Social Capital Have an Economic Payoff? A Cross-Country Investigation," The Quarterly Journal of Economics, MIT Press, vol. 112(4), pages 1251-88, November.
  14. 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.
  15. International Monetary Fund, 2009. "Commodity Terms of Trade; The History of Booms and Busts," IMF Working Papers 09/205, International Monetary Fund.
  16. Robert P. Flood & Nancy P. Marion, 2002. "Holding International Reserves in an Era of High Capital Mobility," IMF Working Papers 02/62, International Monetary Fund.
  17. Hausmann, Ricardo & Panizza, Ugo & Rigobon, Roberto, 2006. "The long-run volatility puzzle of the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 25(1), pages 93-124, February.
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