The macroeconomic role of currency reserve accumulation in emerging markets—The Asian experience

• Author: Theo Berger,Joscha Beckmann,Robert Czudaj
• Published date: 01 January 2018
• Date: 01 January 2018
• DOI: http://doi.org/10.1111/twec.12497

ORIGINAL ARTICLE

The macroeconomic role of currency reserve

accumulation in emerging markets—The Asian

experience

Joscha Beckmann

1,2,3

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Theo Berger

4

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Robert Czudaj

5,6

1

Chair for International Economics, Ruhr University of Bochum, Bochum, Germany

2

Chair for Macroeconomics, University of Duisburg-Essen, Essen, Germany

3

Kiel Institute for the World Economy, Kiel, Germany

4

Chair for Applied Statistics and Empirical Economics, University of Bremen, Bremen, Germany

5

Chair for Empirical Economics, Chemnitz University of Technology, Chemnitz, Germany

6

FOM Hochschule f€

ur Oekonomie & Management, University of Applied Sciences, Essen, Germany

1

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INTRODUCTION

The evolution of currency reserves has become an essential part of the international monetary system,

which is also controversially discussed. As outlined, in first generation models of currency crises

introduced by Flood and Garber (1984) and Krugman (1979), decreasing reserves can trigger specula-

tive attacks under fixed exchange rates once a critical low level is reached. From this perspective, a

high level of currency reserves provides an insurance function against currency crises since they

enable central banks to earn reputation and protect the local currency. While this view assumes that

the local currency faces depreciation pressure, emerging economies might well face an opposite sce-

nario where an accumulation of currency reserves is necessary to prevent the local currency from

appreciating. However, such an export-led growth strategy is not uncontroversial since it increases

the dependency from global growth and is also potentially responsible for global imbalances (Eichen-

green, Chitu, & Mehl, 2016). The recent financial crisis has demonstrated the issue that many emerg-

ing markets initially weathered the financial crisis comparably well due to small exposures in

subprime loans but struggled once the real economies of industrial countries were affected.

Against this background, the impact of currency reserve accumulation is controversially discussed.

Large and prolonged reserve accumulation potentially results in risks such as overheated credit and

asset markets and distortions in the banking systems (Mohanty & Turner, 2006). In a recent study,

Steiner (2014, p. 126) argues that “good intensions may result in bad outcomes”since reserve accu-

mulation potentially destabilises the international financial system and causes crises due to higher sys-

temic risk. Rodrik (2006) also finds that developing countries need to reconsider the optimal level of

foreign exchange reserve accumulation due to social costs. Asia offers a particular interesting exam-

ple in this context. The accumulation of international reserves by several East Asian countr ies is often

associated with a modern version of monetary mercantilism designed to improve competitiveness

although conclusive evidence of this view is hard to establish (Aizenman & Lee, 2008). In addition,

DOI: 10.1111/twec.12497

World Econ. 2018;41:77–99. wileyonlinelibrary.com/journal/twec ©2017 John Wiley & Sons Ltd

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most Asian economies experienced substantial losses of currency reserves and dep reciations against

the US Dollar of at least 20% during the Asian crisis between 1997 and 1998. Over the same time per-

iod, output decreased by at least 5% for most Asian economies. However, the sharp recessions turned

out to be short-lived with all economies recovering quickly. Between 1999 until the beginning of the

subprime crisis in September 2008, foreign exchange reserves held by developing countries had more

than quadrupled, partly as a result of the Asian experience (Beck & Rahbari, 2011). Figure 1 displays

the evolution of currency reserves for the Asian economies under observation (i.e., Malaysia, South

Korea, Thailand and Singapore) from 1980. It is obvious that all of them accumulated significant cur-

rency reserves from the mid-1980s. While all economies except Singapore experienced a loss of

reserves during the crisis in the 1990s, accumulation of reserves continued to an even greater degree

afterwards. This development and the fact that accumulating currency reserves might also fail to pro-

vide an insurance against these depreciations lead to the key question whether accumulating currency

reserves is beneficial from a long-run perspective.

The term beneficial requires further explanations since it can be interpreted in different contexts

related to the real economy or the financial sector. Previous studies have mostly analysed a poten-

tial link between currency reserves and the economic performance. In this vein, we analyse the

long-run relationship between currency reserves, exchange rates, production and interest rates for

four Asian economies. The fact that all variables are considered as endogenous also enables us to

identify potential indirect transmission channels for an effect from currency reserves on economic

growth. The reason for our country choice is that we are interested in capturing country specific

dynamics for economies which have faced currency crises in the past. We also include capital

flows and run recursive estimations as additional robustness checks.

The remainder of this paper is organised as follows. Literature review and theoretical considera-

tions are provided in the next secti on. Section 3 descri bes data and empi rical methodology. Sec-

tion 4 presents our empirical findings, and Section 5 concludes.

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

7

8

9

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13 LTH_R

LMY_R

LKO_R

LSP_R

FIGURE 1 Evolution of currency reserves

Note: The graph displays the evolution of currency reserves for Thailand (TH), Malaysia (MY), Singapore (SP) and

South Korea (KO) in logs between 1980 and 2014. [Colour figure can be viewed at wileyonlinelibrary.com]

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