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Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008

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  • Maurice Obstfeld
  • Jay C. Shambaugh
  • Alan M. Taylor

Abstract

In this paper we connect the events of the last twelve months, "The Panic of 2008" as it has been called, to the demand for international reserves. In previous work, we have shown that international reserve demand can be rationalized by a central bank's desire to backstop the broad money supply to avert the possibility of an internal/external double drain (a bank run combined with capital flight). Thus, simply looking at trade or short-term debt as motivations for reserve holdings is insufficient; one must also consider the size of the banking system (M2). Here, we show that a country's reserve holdings just before the current crisis, relative to their predicted holdings based on these financial motives, can significantly predict exchange rate movements of both emerging and advanced countries in 2008. Countries with large war chests did not depreciate -- and some appreciated. Meanwhile, those who held insufficient reserves based on our metric were likely to depreciate. Current account balances and short-term debt levels are not statistically significant predictors of depreciation once reserve levels are taken into account. Our model's typically high predicted reserve levels provide important context for the unprecedented U.S. dollar swap lines recently provided to many countries by the Federal Reserve.

Suggested Citation

  • Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2009. "Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008," NBER Working Papers 14826, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:14826
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    References listed on IDEAS

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    1. Maurice Obstfeld & Jay C. Shambaugh & Alan M. Taylor, 2010. "Financial Stability, the Trilemma, and International Reserves," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 57-94, April.
    2. Sachs, Jeffrey D., 1998. "Creditor panics: Causes and remedies," Research Notes 98-4, Deutsche Bank Research.
    3. Calvo, Guillermo A. & Mendoza, Enrique G., 1996. "Mexico's balance-of-payments crisis: a chronicle of a death foretold," Journal of International Economics, Elsevier, vol. 41(3-4), pages 235-264, November.
    4. Sebastian Edwards, 2007. "Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences," NBER Books, National Bureau of Economic Research, Inc, number edwa06-1, July.
    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. 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.
    7. Roberto Chang & Andres Velasco, 2001. "A Model of Financial Crises in Emerging Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 116(2), pages 489-517.
    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. Calvo, Guillermo A, 1996. "Capital Flows and Macroeconomic Management: Tequila Lessons," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 1(3), pages 207-223, July.
    10. Velasco, Andres, 1987. "Financial crises and balance of payments crises : A simple model of the southern cone experience," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 263-283, October.
    11. Klein, Michael W. & Shambaugh, Jay C., 2008. "The dynamics of exchange rate regimes: Fixes, floats, and flips," Journal of International Economics, Elsevier, vol. 75(1), pages 70-92, May.
    12. Jay C. Shambaugh, 2004. "The Effect of Fixed Exchange Rates on Monetary Policy," The Quarterly Journal of Economics, Oxford University Press, vol. 119(1), pages 301-352.
    13. Sebastian Edwards, 2007. "Introduction to "Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences"," NBER Chapters,in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 1-18 National Bureau of Economic Research, Inc.
    14. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 1-80.
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    More about this item

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • O24 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Trade Policy; Factor Movement; Foreign Exchange Policy

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