International reserves and growth: assessing the mercantilist motive in Latin America

Abstract

Official reserves have increased to unprecedented levels since the mid-1990s, particularly in developing economies. One of the reasons ascribed for accumulating official reserves is the so-called mercantilist motive. This motive is seen as a part of an active industrial policy in the sense that these resources allow the monetary authorities to maintain a stable and undervalued real exchange rate, promoting economic growth and development via the tradable goods sector. In this paper we attempt to assess this motive using data for ten selected Latin American economies during the period 1996–2011. Unlike most previous work done on this topic, we consider official reserves as one of the determinants of the real exchange rate. Our econometric findings indicate that international reserves in the region appreciate the real exchange rate. This result suggests that the strategy of hoarding reserves in Latin America has not promoted economic growth and development.

Key words:

• International reserves
• real exchange rate
• Latin America
• growth and development

JEL classifications:

• F31
• F41
• F43

Notes

¹Dornbush (1980) shows that a currency devaluation is equivalent to, that is, has the same effects as, a policy of subsidizing the tradable sector. In addition, currency devaluation has been classified as a market-friendly policy because such a subsidy does not involve any micromanagement on the part of bureaucrats (see Rodrik, 2008, p. 23).

²To our knowledge, there are only two papers that have included official reserves as a determinant of the real exchange rate (see Aizenman, 2008; Nassif et al., 2011). The paper of Aizenman (2008), it is important to mention, points out that the mercantilist case for hoarding international reserves, as an ingredient of an export led-growth strategy, is dubious. On the other hand, the paper of Nassif et al (2011) does not to test the mercantilist motive, it rather aims at investigating the recent determinants of Brazil’s real exchange rate.

³According to the United Nations (2001), the accumulation of international reserves started in the late 1990s, during the aftermath of the East Asian financial crisis of 1997–1998.

⁴Rodrik (2003, p. 22), for example, in this respect points out that “the real exchange rate is defined as the relative price of tradables to non-tradables. In practice, this price ratio tends to move in tandem with the nominal exchange rate.”

⁵A number of similar events in other Latin American economies followed the Mexican “peso” crisis of 1994–1995: in Brazil in 1998–1999, in Ecuador in 1999, in Argentina in 2001, in Uruguay in 2002, and in the Dominican Republic in 2003.

⁶We constructed the real exchange rate as e = E(P* / P), where E is the nominal exchange rate (local currency/per U.S. dollar) and P and P* are the domestic and U.S. consumer price indexes, respectively. Increases in the real exchange rate thus indicate depreciation whereas decreases indicate appreciation.

⁷Measured by GDP per capita, economic development in these economies has grown 2.3 percent on average during the period 1996–2011. This rate largely overwhelms the economic development of the previous three lustrums (0.23 percent on average).

⁸We decide not to include official aid and workers’ remittances because they might introduce endogeneity problems in our estimation procedure (see, e.g., Amudeo-Darantes and Pozo, 2004).

Additional information

Notes on contributors

Moritz Cruz

Moritz Cruz is a professor in the Instituto de Investigaciones Económicas at the Universidad Nacional Autónoma de México.