Adjustment Patterns to Commodity Terms of Trade Shocks: The Role of Exchange Rate and International Reserves Policies

45 Pages Posted: 25 Dec 2011 Last revised: 27 Dec 2011

See all articles by Joshua Aizenman

Joshua Aizenman

National Bureau of Economic Research (NBER)

Sebastian Edwards

University of California, Los Angeles (UCLA) - Global Economics and Management (GEM) Area; National Bureau of Economic Research (NBER)

Daniel Riera-Crichton

Bates College

Date Written: December 2011

Abstract

We analyze the way in which Latin American countries have adjusted to commodity terms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degree to which the active management of international reserves and exchange rates impacted the transmission of international price shocks to real exchange rates. We find that active reserve management not only lowers the short-run impact of CTOT shocks significantly, but also affects the long-run adjustment of REER, effectively lowering its volatility. We also show that relatively small increases in the average holdings of reserves by Latin American economies (to levels still well below other emerging regions current averages) would provide a policy tool as effective as a fixed exchange rate regime in insulating the economy from CTOT shocks. Reserve management could be an effective alternative to fiscal or currency policies for relatively trade closed countries and economies with relatively poor institutions or high government debt. Finally, we analyze the effects of active use of reserve accumulation aimed at smoothing REERs. The result support the view that "leaning against the wind" is potent, but more effective when intervening to support weak currencies rather than intervening to slow down the pace of real appreciation. The active reserve management reduces substantially REER volatility.

Suggested Citation

Aizenman, Joshua and Edwards, Sebastian and Riera-Crichton, Daniel, Adjustment Patterns to Commodity Terms of Trade Shocks: The Role of Exchange Rate and International Reserves Policies (December 2011). NBER Working Paper No. w17692. Available at SSRN: https://ssrn.com/abstract=1976488

Joshua Aizenman (Contact Author)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Sebastian Edwards

University of California, Los Angeles (UCLA) - Global Economics and Management (GEM) Area ( email )

110 Westwood Plaza
Box 951481
Los Angeles, CA 90095-1481
United States
310-206-6797 (Phone)
310-206-5825 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Daniel Riera-Crichton

Bates College ( email )

Lewiston, ME 04240
United States

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