Examining the interactions of high reserves and weak fundamentals in currency crises

Abstract

This article tackles the issue of reserve adequacy measure by examining the interaction of high reserves and weak fundamentals in crises. The author extends the analysis of Sachs et al. (1996) by adopting on two-step regressions. The first helps find the significant weak fundamental variables. The second determines the appropriate adequate reserve level.

Acknowledgements

The author thanks Thomas Willett and Ramkishen Rajan for insightful comments. The author also acknowledges the generous financial supports from Haynes Dissertation Grant in Claremont Graduate University and the Phi Beta Kappa Scholarship.

Notes

¹ Their results are reported in Willett et al. (2005).

² In the line of literature about ‘reserve adequacy’, there has not been any empirically tested reserve adequacy measure. All the measures proposed in the literature so far are pretty arbitrary. This article is the first one to give reserve adequacy measure with empirical supports.

³ Annex 1 provides the details about the ways to construct crisis indices.

⁴ For the rationales of using such composite variables, see Corsetti et al. (2001) and Willett et al. (2005).