Climate Disaster Losses and Foreign Exchange Reserve Dynamics: Evidence of East Asia Pacific

Abstract

This paper examines the relationship between foreign exchange reserves (FERs) and climate disaster losses (CDLs) in the East Asia Pacific region. To guide the empirical work, we use the bootstrap Granger rolling window estimation to capture the dynamic relationship between the two variables. It is suggested that CDLs positively affect the central banks’ FERs in East Asia Pacific countries, but this relationship appears to be weakening recently. FERs are shown to reduce CDLs. The results are supported by the small open economy model in which the central bank decides jointly on FERs and external debt. With the balance of payments deteriorating, CDLs can lead to a sudden stop of international capital flows, which is destructive to economic development. Therefore, when severe climate disasters are anticipated, the central bank accumulates FERs in advance. If unexpected climate disasters occur, central banks may become more precautious and increase FERs. Therefore, the central bank should consider the risk of climate change and hold an appropriate amount of FERs but FERs are not the more the better; the government should strengthen infrastructure construction to resist climate disasters.