Foreign Exchange Reserves and Import Demand: Evidence from Latin America

Abstract

This paper investigates the impact of foreign reserves, domestic real income and relative import prices on import demand for seven Latin American countries. We differentiate empirically between the short‐run and long‐run impact of reserves, income and prices on imports. The paper has three main results. First, we show that there exists a unique long‐run relationship among real imports, real income, relative import prices and real foreign exchange reserves for all seven countries. Second, we find that increases in foreign exchange reserves exert a significant positive effect on import demand in both the long run and the short run in all countries. However, the economic impact of foreign exchange reserves is rather small. Finally, we find that the long‐ and short‐run impact of real domestic income on import demand is positive as well, while the effect of relative prices is negative.