Precautionary demand for foreign assets in sudden stop economies
Subtitle: an assessment of the new merchantilism
By: Ceyhun Bora Durdu, Enrique G. Mendoza, Marco E. Terrones.
Contributors: Mendoza, Enrique G., 1963-; Terrones, Marco.; National Bureau of Economic Research.
Series: NBER working paper series -- no. 13123.; Working paper series (National Bureau of Economic Research) -- working paper no. 13123.
Publisher: National Bureau of Economic Research
Published: 2007
Place of publication: Cambridge, Mass
Language: eng
Number of pages: 27
Subjects: Business cycles -- Mathematical models; Equilibrium (Economics) -- Mathematical models; Globalization
Description: "Financial globalization was off to a rocky start in emerging economies hit by Sudden Stops since the mid 1990s. Foreign reserves grew very rapidly during this period, and hence it is often argued that we live in the era of a New Merchantilism in which large stocks of reserves are a war-chest for defense against Sudden Stops. We conduct a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework with incomplete asset markets in which precautionary saving affects foreign assets via three mechanisms: business cycle volatility, financial globalization, and Sudden Stop risk. In this framework, Sudden Stops are an equilibrium outcome produced by an endogenous credit constraint that triggers Irving Fisher's debt-deflation mechanism. Our results show that financial globalization and Sudden Stop risk are plausible explanations of the observed surge in reserves but business cycle volatility is not. In fact, business cycle volatility has declined in the post-globalization period. These results hold whether we use the formulation of intertemporal preferences of the Bewley-Aiyagari-Hugget class of precautionary savings models or the Uzawa-Epstein setup with endogenous time preference."
Notes: "May 2007"

Includes bibliographical references (p. 26-27).

Also available in PDF from the NBER world wide web site (www.nber.org).