Editors' Summary

The Brookings Panel on Economic Activity held its eighty-third conference in Washington, D.C., on March 29 and 30, 2007. This issue of the Brookings Papers includes the papers and discussions presented at the conference. The five papers in this issue span a range of domestic and global issues of current importance. The first paper uses risk analysis to assess the large foreign reserves holdings of emerging market countries. The second paper models the role of information technology in the rapid productivity growth of the past decade. The third paper examines the relation between foreign capital inflows and growth among nonindustrialized economies. The fourth paper estimates the effects of dividends on consumption and the implied effects of the 2003 dividend tax cuts. The final paper looks for explanations for the failure of long-term rates to respond as expected to the Federal Reserve's monetary tightening of recent years.

In 2005 the international reserves of emerging market countries reached nearly $2 trillion, four times their level of the early 1990s relative to GDP. Some commentators have argued that such massive reserves are prudent insurance against the increased volatility of capital flows accompanying financial globalization, but others claim they are excessive and that these countries could put the funds to better use toward their economic development. In the first article of this issue, Olivier Jeanne examines whether the risk of currency crisis or a sudden cutoff in lending justifies the level of reserves held by these countries.

Historically, various rules of thumb have been used to make this assessment. Jeanne is much more ambitious. He calibrates a formal model of optimal reserves holdings to country-specific empirical estimates of the parameters crucial to determining this optimum. He finds that the reserves held by most Latin American countries can be rationalized with this model, but the risks of a capital account crisis confronting the Asian emerging economies in his sample are much too small to justify their current holdings. This conclusion has implications both for the need for further accumulation and for the management of existing reserves. In the final sections of the paper, Jeanne considers the opportunities for emerging market countries to diversify their investment, the implications of such a change in investment behavior for global financial markets, and possible international arrangements for using this wealth to more efficiently insure against future crises and to promote financial development.

Jeanne begins by documenting the recent buildup in international reserves by thirty-two emerging market countries. In the decade before 1990 these countries held reserves averaging 5 percent of their GDP, a ratio comparable to that in industrial economies. Since then, however, this average has grown by a factor of four, to roughly 22 percent of GDP by 2005. More than half of the dollar growth in these countries' reserves during the period took place in Asia following the 1997-98 crisis in that region. China's ratio of reserves to GDP is similar to that of other emerging Asian countries, but because of its size China now holds the largest stock of international reserves in the world.

Growth in a country's international reserves is necessarily financed by some combination of current account surpluses and capital inflows. Among the Asian emerging market countries, current account surpluses accounted for 63 percent of their reserves accumulation during 2000-05. In contrast, the Latin American economies ran sizable current account deficits, and capital inflows amounted to 137 percent of their reserves accumulation. The experience of the Asian economies dominates the overall picture: for all emerging market countries combined, current account surpluses account for almost 60 percent of reserves accumulation during this period. Jeanne notes that the flow of capital from developing to developed economies was equivalent to more than 40 percent of the current account deficit of the United States in the same period. He also documents various salient features of the gross capital flows underlying the net flows to and from countries in his sample. Reserves accumulation constitutes more than 60 percent of the gross foreign asset accumulation of these countries. In contrast, foreign direct investment (FDI) accounts for almost 70...