Do Exchange Rate Shocks Have Asymmetric Effects on Reserve Accumulation? Evidence from Emerging Markets*

Date01 October 2019
DOIhttp://doi.org/10.1111/sjoe.12348
Published date01 October 2019
Scand. J. of Economics 121(4), 1561–1586, 2019
DOI: 10.1111/sjoe.12348
Do Exchange Rate Shocks Have Asymmetric
Effects on Reserve Accumulation? Evidence
from Emerging Markets*
Shiu-Sheng Chen
National TaiwanUniversity, Taipei 10617, Taiwan
sschen@ntu.edu.tw
Tzu-Yu Lin
National Cheng Kung University, Tainan 70101, Taiwan
tylin@mail.ncku.edu.tw
Abstract
It is generally argued that central banks in emerging market countries, motivated by a desire to
defend export competitiveness, tend to intervene in foreign exchange markets to limit currency
appreciations rather than depreciations. Using panel data from 13 emerging market countries for
the period 1998:M1 to 2016:M12, we find that exchange rate shocks play an important role in
determining the accumulation of international reserves. Moreover, we find evidencethat central
banks in emerging markets tend to followa “leaning against the depreciation wind” policy, rather
than the appreciation wind (i.e., we provide evidenceof a “fear of depreciation”).
Keywords: Asymmetric exchange rate policy; fear of depreciation; foreign exchange reserves
JEL classification:F31; F33; F37
I. Introduction
It is argued that as international capital markets become more integrated,
countries must choose between one of two extremes: either a free-floating
regime or a firmly fixed exchange rate regime. This bipolar proposition is
variously referred to as the “vanishing intermediate regime” or the “missing
middle” (see Frankel and Schmukler, 2000). However, observers have noted
that many countries that claim to allow their exchange rate to float do not.
For instance, Calvo and Reinhart (2002) argue that if a country follows
a pure-float exchange rate policy, the volatility of exchange rates should
be large, whereas the volatility of foreign exchange reserves should be
small (thereby indicating a lack of official intervention). To test this, they
calculate the probability that the monthly percentage change in nominal
*We would like to thank two anonymous referees for comments and suggestions on an earlier
version of this paper.Any remaining errors are our own.
C
The editors of The Scandinavian Journal of Economics 2019.
1562 Asymmetric effects of exchange rate shocks
exchange rates and foreign exchange reserves falls within the band of ±1to
±2.25 percent. Using the United States and Japan as benchmarks, Calvo and
Reinhart (2002) reveal that the average changes in the nominal exchange
rates and foreign exchange reserves for countries claiming an independently
floating system lie far from the benchmarks, and are instead very close to
those for managed-float countries. They refer to these findings as a “fear
of floating”.
This is interesting, as exchange rate stability remains a major policy
concern because of the high pass-through from exchange rates to domestic
inflation in developing countries (see Calvo and Reinhart, 2002). Moreover,
because market inefficiency/instability in foreign exchange markets can
cause the exchange rate to deviate from a rate consistent with economic
fundamentals and make it highly volatile, it is not surprising that central
banks might adopt a managed-float exchange rate regime as a “leaning-
against-the-wind” policy; that is, they sell the home currency while it
is appreciating and buy it back when it depreciates. However, under the
frequent and intensive interventions implied by this policy, many developing
countries have built up substantial foreign exchange reserves. To illustrate,
Figures 1–3 depict the evolution of foreign exchange reserve holdings (total
reserves minus gold) for several emerging market economies, including
Brazil, Chile, India, Indonesia, Korea, Malaysia, Mexico, the Philippines,
Poland, Russia, Singapore, Taiwan, and Turkey. As shown, the pace of the
accumulation of foreign reserves by emerging economies has accelerated
dramatically since the late 1990s. For example, the total foreign reserve
holdings for just these 13 countries increased 860 percent from 289,265
million US dollars (USD) in 1993 to 2,779,429 million USD in 2016.
Such a substantial accumulation of international reserves might suggest
that the goal of intervention is not simply to reduce exchange rate
fluctuations or to hold reserves for precautionary reasons. In particular, in
order to prevent their competitiveness from deteriorating, some emerging
market economies have intervened in foreign exchange markets to prevent
or at least slow the appreciation of their currencies. This mercantilist
exchange rate policy is now referred to as “currency manipulation” (see
Neely, 2011) or a “fear of appreciation” (see Levy-Yeyati et al., 2013), as
it is aimed at gaining an advantage in trade. One consequence has been a
fierce debate among international policy-makers and analysts. For example,
just before the G20 meeting in Seoul in September 2010, the Brazilian
finance minister, Guido Mantega, spoke of an “international currency war”
in which devaluing currencies artificially had become a routine strategy
worldwide. Bernanke (2010) uses the annual percentage change in the real
effective exchange rate (REER) along with the accumulation of foreign
exchange reserves as a share of GDP over a corresponding period to
measure the degree of intervention and notes that “the relationship evident
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The editors of The Scandinavian Journal of Economics 2019.

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