Excess liquidity and the foreign currency constraint: the case of monetary management in Guyana

Abstract

This article examines why commercial banks in Guyana demand nonremunerated excess reserves, a phenomenon that became even more widespread after financial liberalization. Despite the removal of capital controls, banks do not invest all excess reserves in a safe foreign asset because the central bank maintains an unofficial foreign currency constraint by accumulating international reserves. The findings suggest that commercial banks do not demand excess reserves for precautionary purpose–which is the conclusion of several other studies–but rather because of the maintained constraint. The estimated sterilization coefficient is consistent with the hypothesis of an enforced constraint. The results, moreover, suggest an alternative way of looking at the monetary transmission mechanism in developing countries. The central bank maintains price and exchange rate stability through the accumulation of foreign reserves.