Do Central Banks Rebalance Their Currency Shares?

Abstract

Do central banks rebalance their currency shares? The answer matters because the dollar’s predominant role in large official reserve holdings means that widespread rebalancing requires central banks to buy (sell) a depreciating (appreciating) dollar, stabilising its value against other major currencies. We hypothesise that larger reserve holdings have led central banks to approach their investment more systematically and to make rebalancing in the face of exchange rate changes the norm. We illustrate the choice with two polar case studies: the US clearly does not rebalance its small FX reserves; Switzerland does rebalance its very large reserves, so that changes in exchange rates do not move its currency allocation. Our hypothesis finds partial support in global aggregated data. They reject both no rebalancing and full rebalancing and point to emerging market economies as the source of the aggregate result. We also test for rebalancing with panel data and find that our sample economies on average again behave in intermediate fashion, partially but not fully rebalancing. However, when observations are weighted by the size of reserves, the panel analysis finds full rebalancing. A variety of control variables and splits of the panel sample do not alter the thrust of these findings. Central banks rebalance their FX reserves extensively but not uniformly. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.