Reserve Requirements on Eurocurrency Deposits: Implications for Eurodeposit Multipliers, Control of a Monetary Aggregate, and Avoidance of Redenomination Incentives

Abstract

In this paper a two-country model of international financial markets is employed to analyze some implications of placing reserve requirements on Eurocurrency deposits. The features of this model are described in Section II. Many earlier analyses of the Eurocurrency markets focused on Eurodeposit multiplier, the response of equilibrium holdings of Eurodeposits to an autonomous shift from domestic deposits into EUrodeposits. The analysis in Section II is a continuation of this tradition; there the model is used to trace out the implications of a shict from domestic demand deposits to Eurodollar deposits for equilibrium holdings of Eurodollar deposits and total Eurocurrency deposits. The approach of recent contributions to analysis of monetary policy maknig has been to evaluate alternative operating procedures and suggested changes in financial regulations under various assumptions aboud the relative magnitudes of different kinds of shocks to the economy. This is the approach adopted in Section IV where teh effects of changes in Eurocurrency reserve requirements on the deviations of a monetary aggregate from a chosen target value are investigated. There it is assumed taht the authorities set the supply of high-powered monety in an attempt to achieve a desired value for a monetary aggregate, which is their intermeidate target. Deviations between the actual and desired values arice because the authorities have incomplete current information about the shocks which buffet the financial system. In Sections II, III, and IV one possible system of Eurocurrency reserve requirements is analyzed. In Section V it is demonstrated that under some alternative systems the imposition of Eurocurrency reserve requirements may give rise to an inventive for Eurocurrency deposits denominated in one ore the other ucrrency to be redenominated so that all Eurocurrency deposits are denominated in a single currency. This section also includes a discussion of how structure Eurocurrency reserve requirements so as to avoid giving rise to redenomination incentives. Section VI contains some conclusions.