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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 ()

Santa Cruz Department of Economics, Working Paper Series from Department of Economics, UC Santa Cruz

Abstract: We analyze the way in which Latin American countries have adjusted to commodityterms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degreeto which the active management of international reserves and exchange rates impacted thetransmission of international price shocks to real exchange rates. We find that active reservemanagement not only lowers the short-run impact of CTOT shocks significantly, but alsoaffects the long-run adjustment of REER, effectively lowering its volatility. We also show thatrelatively small increases in the average holdings of reserves by Latin American economies (tolevels still well below other emerging regions current averages) would provide a policy tool aseffective 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 forrelatively trade closed countries and economies with relatively poor institutions or highgovernment debt. Finally, we analyze the effects of active use of reserve accumulation aimedat smoothing REERs. The result support the view that “leaning against the wind” is potent, butmore effective when intervening to support weak currencies rather than intervening to slowdown the pace of real appreciation. The active reserve management reduces substantiallyREER volatility.

Keywords: Social and Behavioral Sciences; Terms of trade; the real exchange rate; international reserves; commodity price shocks; volatility; exchange rate regime (search for similar items in EconPapers)
Date: 2012-01-10
New Economics Papers: this item is included in nep-lam, nep-mon and nep-opm
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Journal Article: 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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