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

C. Bora Durdu, Enrique Mendoza and Marco Terrones

No 13123, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: 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.

JEL-codes: D52 E44 F32 F41 (search for similar items in EconPapers)
Date: 2007-05
New Economics Papers: this item is included in nep-dge and nep-mac
Note: IFM
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Citations: View citations in EconPapers (46)

Published as Durdu, Ceyhun Bora & Mendoza, Enrique G. & Terrones, Marco E., 2009. "Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism," Journal of Development Economics, Elsevier, vol. 89(2), pages 194-209, July.

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Related works:
Journal Article: Precautionary demand for foreign assets in Sudden Stop economies: An assessment of the New Mercantilism (2009)
Working Paper: Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Mercantilism (2008)
Working Paper: Precautionary demand for foreign assets in sudden stop economies: an assessment of the new mercantilism (2007)
Working Paper: Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism (2007)
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