Working Paper: NBER ID: w10534
Authors: Joshua Aizenman; Yeonho Lee; Yeongseop Rhee
Abstract: This paper characterizes the precautionary demand for international reserves driven by the attempt to reduce the incidence of costly output decline induced by sudden reversal of short-term capital flows. It validates the main predictions of the precautionary approach by investigating changes in the patterns of international reserves in Korea in the aftermath of the 1997-8 crisis. This crisis provides an interesting case study, especially because of the rapid rise in Korea's financial integration in the aftermath of the East-Asian crisis, where foreigners' shareholding has increased to 40% of total Korean market capitalization. We show that the crisis led to structural change in the hoarding of international reserves, and that the Korean monetary authority gives much greater attention to a broader notion of 'hot money,' inclusive of short-term debt and foreigners' shareholding.
Keywords: international reserves; capital mobility; Korea; precautionary demand; financial crisis
JEL Codes: F15; F32; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sudden stops in capital flows (F32) | increase in precautionary demand for reserves (E41) |
| economic costs associated with liquidity crises (G01) | increase in precautionary demand for reserves (E41) |
| trade openness (F43) | increase in international reserves (F30) |
| financial openness (F30) | increase in international reserves (F30) |
| structural changes in reserve management (E63) | increase in precautionary demand for reserves (E41) |
| precautionary demand for reserves (E41) | increase in international reserves (F30) |
| current account surplus (F32) | increase in international reserves (F30) |
| equity inflows (F21) | increase in international reserves (F30) |