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Adjustment Patterns to Commodity Terms of Trade Shocks: the Role of Exchange Rate and International Reserves Policies

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Adjustment Patterns to Commodity Terms of Trade Shocks: the Role of Exchange Rate and International Reserves Policies
Journal of International Money and Finance 31 (2012) 1990–2016

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Journal of International Money and Finance journal homepage: www.elsevier.com/locate/jimf

Adjustment patterns to commodity terms of trade shocks: The role of exchange rate and international reserves policiesq
Joshua Aizenman a, b, *, Sebastian Edwards b, c, Daniel Riera-Crichton d a University of California, Santa Cruz, USA NBER, USA University of California, Los Angeles, USA d Bates College, USA b c

a b s t r a c t
Jel classification: F15 F31 F32 F36 O13 O54 Keywords: Terms of trade The real exchange rate International reserves Commodity price shocks Volatility Exchange rate regime

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

q This is a revised version of a paper presented at the JIMF 4th conference at UCSC, International Policy Implications and Lessons from the Global Financial Crisis. We thank Michael


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