«Role Reversal in Global Finance Eswar S. Prasad I. Introduction The global financial crisis has sparked a reconsideration of the role of unfettered ...»
in dollars. This argument assumes that the high U.S. debt levels will not have major inflationary consequences in the United States. Another issue is that, in the process of sterilizing inflows, the People’s Bank of China (PBOC) has issued central bank bonds that are effectively liabilities denominated in renminbi and match a significant proportion of the dollar assets. Even if the capital loss on the dollar-denominated assets nets out within the government as the PBOC bonds are held by state-owned banks, the real cost is the massive financial repression needed to maintain the tightly-managed exchange rate regime.
A speech by Jose De Gregorio (2011), Chile’s central bank governor, explicitly references reserve accumulation for precautionary purposes. Obstfeld, Shambaugh and Taylor (2010) estimate a model of reserve stocks that includes M2, financial openness, ability to access foreign currency through debt markets, and exchange rate policy. These variables do better at explaining emerging markets’ reserve accumulation during the 2000s than traditional models that only include imports and external short-term debt. For other analyses of accumulation motives and criteria for reserve adequacy, see Aizenman and Lee (2007), Jeanne (2007) and Dominguez, Hashimoto and Ito (2011).
See Prasad (2009a) for a discussion of this issue in the context of China. Lardy (2010) estimates the cost to households of financial repression in China—as captured by the low or negative real interest rates paid on households’ bank deposits— at about 4 percent of GDP per annum.
Some commentators have suggested that these premiums could be linked to market-based measures of country risk as captured by debt or CDS spreads. However, policymakers will be reluctant to participate in an insurance scheme where premiums are subject to shifts in market sentiments that may or may not be based on economic fundamentals.
There is some evidence that signing up for the FCL reduced spreads on these countries’ debt, but that evidence has apparently not been sufficient to overcome the stigma effect as there have been no additional takers for the FCL. The poor cousin of the FCL is the Precautionary Credit Line (PCL), designed to “meet the needs of countries that, despite having sound policies and fundamentals, have some remaining vulnerabilities that preclude them from using the FCL.” Shockingly, only one country—Macedonia—has so far volunteered to have its policies rated as being good but not quite good enough for the PCL.
Obstfeld (2011) makes this point and discusses other impediments to the SDR becoming a global reserve currency.
Even though the insurance premiums would be invested in advanced economy
There are of course exceptions. One is Turkey, which is in a vulnerable position as it has a large current account deficit and relies mainly on volatile portfolio equity inflows to finance that deficit.
Kose and Prasad (2010), Frankel and Saravelos (2011) and Gourinchas and Obstfeld (2011) identify rapid expansion of domestic credit in the run-up to the recent crisis as a factor that led to worse outcomes for some emerging markets, particularly those in emerging Europe.
Ye (2011) reports preliminary evidence that greater financial openness is associated with greater wage inequality among emerging market economies. Rajan (2010) discusses how, even in the United States, inequality and a feeble safety net led to distorted government policies that ultimately led to an unraveling of the financial system.
See, for instance, Krueger and Yoo (2002).
For more discussion of the potential collateral benefits of financial globalization and why they may be more important than the direct financing effects of foreign capital, see Kose, Prasad, Rogoff and Wei (2009).
See, for instance, Magud, Reinhart and Rogoff (2010). Kose, Prasad, Rogoff
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