Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism

43 Pages Posted: 28 Dec 2007

See all articles by Ceyhun Bora Durdu

Ceyhun Bora Durdu

Federal Reserve Board

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Marco E. Terrones

International Monetary Fund (IMF)

Date Written: December 2007

Abstract

Financial globalization had a rocky start in emerging economies hit by Sudden Stops. Foreign reserves have grown very rapidly since then, as if those countries were practicing a New Mercantilism that views foreign reserves as a war-chest for defense against Sudden Stops. This paper conducts a quantitative assessment of this argument using a stochastic intertemporal equilibrium framework in which precautionary foreign asset demand is driven by output variability, financial globalization, and Sudden Stop risk. In this framework, credit constraints produce endogenous Sudden Stops. We find that financial globalization and Sudden Stop risk can explain the surge in reserves but output variability cannot. These results hold using the intertemporal preferences of the Bewley-Aiyagari-Hugget precautionary savings model or the Uzawa-Epstein setup with endogenous impatience.

Keywords: Fisherian deflation, liability dollarization, financial globalization, credit constraints, precautionary saving, new mercantilism, sudden stops

JEL Classification: F41, F32, E44, D52

Suggested Citation

Durdu, Ceyhun Bora and Mendoza, Enrique G. and Terrones, Marco E., Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism (December 2007). FRB International Finance Discussion Paper No. 911. Available at SSRN: https://ssrn.com/abstract=1078924 or http://dx.doi.org/10.2139/ssrn.1078924

Ceyhun Bora Durdu (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
2024523775 (Phone)

HOME PAGE: http://www.ceyhunbora.com

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

Marco E. Terrones

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-4329 (Phone)

HOME PAGE: http://imf.org/external/np/CV/AuthorCV.aspx?AuthID=171

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