Working Paper: NBER ID: w14826
Authors: Maurice Obstfeld; Jay C. Shambaugh; Alan M. Taylor
Abstract: In this paper we connect the events of the last twelve months, "The Panic of 2008" as it has been called, to the demand for international reserves. In previous work, we have shown that international reserve demand can be rationalized by a central bank's desire to backstop the broad money supply to avert the possibility of an internal/external double drain (a bank run combined with capital flight). Thus, simply looking at trade or short-term debt as motivations for reserve holdings is insufficient; one must also consider the size of the banking system (M2). Here, we show that a country's reserve holdings just before the current crisis, relative to their predicted holdings based on these financial motives, can significantly predict exchange rate movements of both emerging and advanced countries in 2008. Countries with large war chests did not depreciate -- and some appreciated. Meanwhile, those who held insufficient reserves based on our metric were likely to depreciate. Current account balances and short-term debt levels are not statistically significant predictors of depreciation once reserve levels are taken into account. Our model's typically high predicted reserve levels provide important context for the unprecedented U.S. dollar swap lines recently provided to many countries by the Federal Reserve.
Keywords: financial instability; international reserves; central bank swap lines; 2008 financial crisis
JEL Codes: E42; E44; E58; F21; F31; F33; F36; F41; F42; O24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher-than-expected reserves (F31) | less likely to experience currency depreciation (F31) |
| insufficient reserves (Q30) | likely to depreciate (E20) |
| reserves-to-GDP ratio (E20) | currency stability (F31) |
| actual reserves (Q30) | predicted reserves (L71) |
| current account balances (F32) | depreciation (D25) |
| short-term debt levels (H63) | depreciation (D25) |