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Adjustment patterns to commodity terms of trade shocks: The role of exchange rate and international reserves policies

Joshua Aizenman (), Sebastian Edwards and Daniel Riera-Crichton ()

Journal of International Money and Finance, 2012, vol. 31, issue 8, 1990-2016

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.

Keywords: Terms of trade; The real exchange rate; International reserves; Commodity price shocks; Volatility; Exchange rate regime (search for similar items in EconPapers)
JEL-codes: F15 F31 F32 F36 O13 O54 (search for similar items in EconPapers)
Date: 2012
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Working Paper: Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies (2012) Downloads
Working Paper: Adjustment patterns to commodity terms of trade shocks: the role of exchange rate and international reserves policies (2011) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:31:y:2012:i:8:p:1990-2016

DOI: 10.1016/j.jimonfin.2012.05.003

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