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Exchange Market Pressure and Absorption by International Reserves: Emerging Markets and Fear of Reserve Loss During the 2008-09 Crisis

  • Aizenman, Joshua
  • Hutchison, Michael

This paper evaluates how the global financial crisis emanating from theU.S. was transmitted to emerging markets. Our focus is on the extent thatthe crisis caused external market pressures (EMP), and whether theabsorption of the shock was mainly through exchange rate depreciation orthe loss of international reserves. Controlling for variety of factorsassociated with EMP, we find clear evidence that emerging markets withhigher total foreign liabilities, including short- and long-term debt,equities, FDI and derivative products—had greater exposure and weremuch more vulnerable to the financial crisis. Countries with large balancesheet exposure -- high external portfolio liabilities exceeding internationalreserves—absorbed the global shock by allowing greater exchange ratedepreciation and comparatively less reserve loss. Despite the remarkablebuildup of international reserves by emerging markets during the periodprior to the financial crisis, countries relied primarily on exchange ratedepreciation rather than reserve loss to absorb most of the exchangemarket pressure shock. This could reflect a deliberate choice (“fear ofreserve loss†or competitive depreciations) or market actions that causedvery rapid exchange rate adjustment, especially in emerging markets withopen capital markets, overwhelming policy actions.

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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 qt8g25f4qs.

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Date of creation: 15 Sep 2010
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Handle: RePEc:cdl:ucscec:qt8g25f4qs
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  1. Frankel, Jeffrey, 2008. "New Estimation of China's Exchange Rate Regime," Working Paper Series rwp08-077, Harvard University, John F. Kennedy School of Government.
  2. Girton, Lance & Roper, Don, 1977. "A Monetary Model of Exchange Market Pressure Applied to the Postwar Canadian Experience," American Economic Review, American Economic Association, vol. 67(4), pages 537-48, September.
  3. Stephan Danninger & Irina Tytell & Ravi Balakrishnan & Selim Elekdag, 2009. "The Transmission of Financial Stress From Advanced to Emerging Economies," IMF Working Papers 09/133, International Monetary Fund.
  4. Guillermo A. Calvo & Carmen M. Reinhart, 2000. "Fear of Floating," NBER Working Papers 7993, National Bureau of Economic Research, Inc.
  5. Jeffrey A. Frankel & George Saravelos, 2010. "Are Leading Indicators of Financial Crises Useful for Assessing Country Vulnerability? Evidence from the 2008-09 Global Crisis," NBER Working Papers 16047, National Bureau of Economic Research, Inc.
  6. Joshua Aizenman & Yi Sun, 2009. "The Financial Crisis and Sizable International Reserves Depletion: From 'Fear of Floating' to the 'Fear of Losing International Reserves'?," Working Papers 382009, Hong Kong Institute for Monetary Research.
  7. Obstfeld, Maurice & Rogoff, Kenneth, 2009. "Global imbalances and the financial crisis: products of common causes," Proceedings, Federal Reserve Bank of San Francisco, issue Oct, pages 131-172.
  8. Levy-Yeyati, Eduardo & Sturzenegger, Federico, 2005. "Classifying exchange rate regimes: Deeds vs. words," European Economic Review, Elsevier, vol. 49(6), pages 1603-1635, August.
  9. Obstfeld, Maurice, 2010. "The immoderate world economy," Journal of International Money and Finance, Elsevier, vol. 29(4), pages 603-614, June.
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