Insuring Against Past Perils: The Politics of Post-Currency Crisis Foreign Exchange Reserve Accumulation

Abstract

In the aftermath of financial crises, governments can use economic policy to minimize the risk of future recurrence. Yet not all do so. To explain this divergence in responses I develop a theory of economic policy choice after financial crises. I argue that past financial crises provide information to future governments about the political costs of financial crises. This subsequently informs the need to use economic policy to insure against such crises. Focusing on the accumulation of foreign exchange reserves after currency crises, I find that when past currency crises led to political changes future governments accumulate higher levels of reserves to prevent another crisis from occurring. This effect is stronger when political change occurred in situations where governments would not expect to be held accountable, and when reserve sales were shown to be effective in preventing political change. The theory and empirical results provide an answer as to why countries experiencing a similar form of financial crisis can, nevertheless, vary in their attempts to prevent future recurrence.

Does political regime matter for abnormal hoarding of international exchange reserves?

“…In emerging economies, as highlighted in Dreher and Vaubel (2009), the political business cycle is often represented by changes in reserves that offset spending increases and accelerate money supply. In particular, as highlighted in McGrath (2016), when governments change after crises, successors will be prone to increase demand for reserves as an additional toolkit to keep the macroeconomic situation favorable for re-election in the future.…”

Bailout or bust? Government evaluations in the wake of a bailout

“…Following recent studies on economic policy and policy preferences in response to negative events, we expect that governments have opportunities to not only reduce the severity of punishment for economic downturns, but to increase its level of popularity (Ashworth et al 2018;Gasper and Reeves 2011;McGrath 2017). We propose that voters do not solely rely on information on the state of the economy but react to actual government policy responses, and while the former is often rightfully used as a heuristic for the performance of governments, voters can rely on the policy actions of the government in response to a clearly inadequate status quo (Egan 2014).…”

Міжнародні Резерви Центральних Банків: Критерії Адекватності Та Нагромадження

“…This makes it much more difficult to build a model of the financial sector's adjustment to the exchange rate. Therefore, it is not worthwhile to forecast the exchange rate and determine the behaviour of reserves during a crisis [16].…”