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The emerging markets (EMEs) crisis of the late 1990s marked a turning point in their relations with foreign exchange markets. From this point, they started to accumulate significant amounts of foreign exchange reserves. At the same time, certain countries were accused of manipulating exchange rates in a neo-mercantilist manner. The objective of this paper is to critically assess the theoretical reasoning behind these foreign exchange market interventions. First, we analyze the mainstream theory. They start from the “polar view” of exchange rate regimes: either pure floating or hard-pegs. In this ideal distinction, intervention is only required to sustain hard-peg regimes. Furthermore, mainstream theory views current account deficits as an extra source of savings to fund investment in emerging markets. However, the severity of the 1990s crisis fostered a partial revision of the theory. In special, the dangers of sudden stops of capital together with currency mismatches were recognized. As a consequence, the precautional demand for international reserves is widely accepted as a way to cope with external crises.
In the sequence, the modern money theory is analyzed. According to these authors, autonomy on economic policymaking lies on monetary sovereignty. Therefore, it is essential to avoid any indebtedness in foreign currencies. Given that the country is monetary sovereign, it should let the exchange rate float in order to sustain balanced current account results. Finally, the post-Keynesians and Latin-American structuralist (PKS) theories are reviewed in details. The PKS theory regards the international monetary and financial system (IMFS) as asymmetrical and hierarchical, with a few currencies being widely accepted internationally while the majority is not. Therefore, it should be clear that there is no perfect asset-substitutability in international markets. Therefore, even recognizing the importance of monetary sovereignty, it is not enough to avoid externally induced crises. As a consequence, they recommend active exchange rate policies to ensure financial stability. Moreover, the PKS theory recognizes that competitive exchange rate policies aimed to achieve a stable current account balance can be important to stimulate technological catch-up and long-run productive development by avoiding external constraints.
The different theories are compared against the evidence for the EMEs. Descriptive statistics show the preponderant role of the U.S. dollar on the IMFS. Preliminary results using standard linear regressions presents evidence of a positive relationship between investment and current account balances for the group of emerging markets, in particular for the quantile of “high investment” countries. This evidence contradicts the mainstream theory and is in accordance with PKS theory. Further analyses will be conducted to assess the relations between exchange rate interventions, exchange rate volatility and economic growth.
