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

23 Pages Posted: 29 Mar 2009  

Maurice Obstfeld

University of California, Berkeley - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Jay Shambaugh

Dartmouth College - Department of Economics; Georgetown University - Department of Strategy/Economics/Ethics/Public Policy

Alan M. Taylor

University of California, Davis - Department of Economics; University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: March 2009

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

Obstfeld, Maurice and Shambaugh, Jay and Taylor, Alan M., Financial Instability, Reserves, and Central Bank Swap Lines in the Panic of 2008 (March 2009). NBER Working Paper No. w14826. Available at SSRN: https://ssrn.com/abstract=1369062

Maurice Obstfeld (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-643-9646 (Phone)
510-642-6615 (Fax)

HOME PAGE: http://emlab.berkeley.edu/users/obstfeld/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
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United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Jay Shambaugh

Dartmouth College - Department of Economics ( email )

309 Rockefeller Hall
Hanover, NH 03755
United States
603-646-9345 (Phone)
603-646-2122 (Fax)

HOME PAGE: http://www.dartmouth.edu/~economic/faculty/Shambaugh/

Georgetown University - Department of Strategy/Economics/Ethics/Public Policy

Washington, DC 20057
United States

Alan M. Taylor

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1572 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

University of Virginia - Department of Economics ( email )

P.O. Box 400182
Charlottesville, VA 22904-4182
United States
(434)-924-3177 (Phone)
(434)-982-2904 (Fax)

HOME PAGE: http://people.virginia.edu/~amt7u

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://nber.org

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

HOME PAGE: http://cepr.org

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