Adjustment patterns to commodity terms of trade shocks: The role of exchange rate and international reserves policies

Joshua Aizenman, Sebastian Edwards, Daniel Riera-Crichton

Research output: Contribution to journalArticlepeer-review

62 Scopus citations

Abstract

We analyze the way in which Latin American countries have adjusted to commodity terms of trade (CTOT) shocks in the 1970-2007 period. Specifically, we investigate the degree to which the active management of international reserves and exchange rates impacted the transmission of international price shocks to real exchange rates. We find that active reserve management not only lowers the short run impact of CTOT shocks significantly, but also affects the long run adjustment of REER, effectively lowering its volatility. We also show that relatively small increases in the average holdings of reserves by Latin American economies (to levels still well below other emerging regions current averages) would provide a policy tool as effective 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 for relatively trade closed countries and economies with relatively poor institutions or high government debt. Finally, we analyze the effects of active use of reserve accumulation aimed at smoothing REERs. The result support the view that " leaning against the wind" is potent, but more effective when intervening to support weak currencies rather than intervening to slow down the pace of real appreciation. The active reserve management reduces substantially REER volatility.

Original languageEnglish
Pages (from-to)1990-2016
Number of pages27
JournalJournal of International Money and Finance
Volume31
Issue number8
DOIs
StatePublished - 1 Dec 2012
Externally publishedYes

Keywords

  • Commodity price shocks
  • Commodity price shocks
  • Exchange rate regime
  • Exchange rate regime
  • International reserves
  • International reserves
  • Terms of trade
  • Terms of trade
  • The real exchange rate
  • The real exchange rate
  • Volatility
  • Volatility

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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