Working Paper: NBER ID: w19652
Authors: Carmen M. Reinhart; Takeshi Tashiro
Abstract: It is well understood that investment serves as a shock absorber at the time of crisis. The duration of the drag on investment, however, is perplexing. For the nine Asian economies we focus on in this study, average investment/GDP is about 6 percentage points lower during 1998-2012 than its average level in the decade before the crisis; if China and India are excluded, the estimated decline exceeds 9 percent. We document how in the wake of crisis home bias in finance usually increases markedly as public and private sectors look inward when external financing becomes prohibitively costly, altogether impossible, or just plain undesirable from a financial stability perspective. Also, previous studies have not made a connection between the sustained reserve accumulation and the persistent and significantly lower levels of investment in the region. Put differently, reserve accumulation involves an official institution (i.e., the central bank) funneling domestic saving abroad and thus competing with domestic borrowers in the market for loanable funds. We suggest a broader definition of crowding out, driven importantly by increased "liability" home bias in finance and by official capital outflows. We present evidence from Asia to support this interpretation.
Keywords: Investment; Reserve Accumulation; Financial Crises; Home Bias; Crowding Out
JEL Codes: E02; E5; F30; F4; G01; G15; H6
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Reserve accumulation by central banks (E58) | Decline in investment levels (E22) |
| Competition for domestic savings (E21) | Reserve accumulation by central banks (E58) |
| Reserve accumulation by central banks (E58) | Domestic savings directed towards reserves instead of investments (E21) |
| Home bias in finance (G15) | Preference for domestic savings to be held as reserves (E21) |
| Home bias in finance (G15) | Decline in investment levels (E22) |
| Reserve accumulation by central banks (E58) | Lower investment ratios (G31) |