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© International Monetary Fund
WP/07/146
IMF Working Paper
Research Department
Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism1
Prepared by Ceyhun Bora Durdu, Enrique G. Mendoza, Marco E. Terrones
Authorized for distribution by Stijn Claessens
June 2007
This Working Paper should not be reported as representing the views of the IMF.
The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.
Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops in the 1990s. The surge in foreign reserves since then is viewed as a New Merchantilism in which reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a framework in which precautionary savings affect foreign assets via business cycle volatility, financial globalization, and endogenous Sudden Stops. Our results show that financial globalization and Sudden Stop risk are plausible explanations of the surge in reserves but cyclical volatility, which has declined in the globalization period, is not.
F41, F32, E44, D52
Keywords:
Fisherian Deflation, Liability Dollarization, Credit Constraints, Sudden Stops
Contents
I. Introduction
II. One-Sector Endowment Economy
A. Structure of the Model
B. Equilibrium
C. Calibration
D. Baseline Results
E. Self-Insurance and Business Cycle Volatility
F. Financial Globalization Effects on Foreign Assets
III. Two-Sector Production Economy
A. Structure of the Model
B. Equilibrium and Amplification with Debt-Deflation
C. Calibration
D. Baseline Results
E. Revisiting the Effects of Volatility and Financial Globalization on Foreign Assets
F. Self-Insurance Against Sudden Stops: How Large Should the War-Chest be?
IV. Conclusions
Tables
Table 1. International Reserve Position in Sudden Stop Economies
Table 2. Business Cycles and Financial Globalization
Table 3. Sectoral Volatility and Financial Gloabilization
Table 4. Volatility–Relative to the US
Table 5. Calibration of the one-and- two-sector models
Table 6. Statistical Moments of the Stochastic Stationary State of the One-Sector Economy
Table 7. Statistical Moments of the Stochastic Stationary State of the Two-Sector Economy
Figures
Figure 1. Emerging Market Economies: Financial Integration
Figure 2. Output and Consumption Volatility: Sample of Countries
Figure 3. Sudden Stop Countries: Rolling Standard Deviation of Output Volatility 1/
Figure 4. One-Sector Model: Transitional Cumulative Distributions Functions
Figure 5. One-Sector Model: Transitional Dynamics of Foreign Assets
Figure 6. Effects of Variability & Persistence of Output on
Figure 7. One-Sector Model: Financial Globalization, Foreign Assets,
Figure 8. One- and Two-Sector Models: Financial Globalization, Foreign Assets and
Figure 9. Sudden Stops under Alternative Preference Specifications
Figure 10. Amplication Effects on Impact in the Sudden Stop Region
Figure 11. Transitional Cumulative Distributions in the Binding Economy
References