Accumulation Of Foreign Reserves Research Articles

The role of foreign reserves in inflation dynamics

Purpose – Central banks’ foreign reserve stocks in emerging markets have increased substantially in recent decades. Foreign reserves accumulation has been widely believed as a shock absorber to prevent financial crises. Meanwhile, accelerating foreign reserves might be contradictory to the monetary policy objectives. This research aims to investigate the impact of foreign reserves on the inflation dynamics.Method – We apply the inflation-expectation augmented Phillips curve on the monthly data over the period of 2005(7) to 2020(12) in the case of Indonesia. Findings – We show that stockpiling foreign exchange reserves indeed has an inflationary pressure impact. The central bank's intervention in the foreign exchange market is more significant in selling rather than purchasing foreign exchange. However, the non-monetary factors also play an important role in determining inflation. Implications – Considering channels through which foreign reserves might affect inflation, our findings suggest the monetary authority should be concerned with inflationary expectations in the short term as one of the major policy-driven goals to maintain price stability in the long run.Originality – This paper contributes to the literature on monetary policy in developing countries. Unlike other empirical studies, this research employs the inflation-expectation augmented Phillips curve and accommodates the issue of asymmetric effects of the change in foreign reserves.

The Role of Macro‐Economic Policy in Explaining China's Current Account Surplus

AbstractI assess how much of China's current account surplus can be explained by government policy of capital controls and foreign reserve accumulation during a period of rapid productivity growth. My model can generate an increase in China's current account surplus and foreign reserve holdings. I find that half of the peak in China's current account surplus can be explained by its capital control policies and half by its foreign reserve accumulation policies. Under an open capital account and floating exchange rate, China would have run a current account deficit of 6.5% of GDP.

Nexus between Exchange Rate and Foreign Reserves on Economic Growth in Nigeria (1980-2020)

Numerous research in Nigeria on the interaction effect between the exchange rate and foreign reserves have been marginalized; this has therefore informed this study to investigate the nexus between exchange rate and foreign reserves, with focus on the Nigerian economy. External reserve was used as the dependent variable, exchange rate, inflation, non-oil export, oil export, and real interest rate, were used as the independent variables. Time series data spanning 1980 to 2020 was used. The study employed the Bound Auto Regressive Distributed Lag (ARDL) co-integrating test approach for evaluation. The results showed that exchange rate have a positive and significant impact on foreign reserves. The granger causality test revealed a unidirectional causality running from exchange rate to foreign reserves. This study recommends that the government should diversify the economy to increase the productivity of other sectors of the economy; this would by implication boost the export of the country thereby leading to accumulation of huge foreign reserves.

Cost of foreign reserve accumulation in emerging market and developing economies

PurposeThis paper aims to obtain a recent estimate of the cost of precautionary foreign reserve accumulation that emerging market and developing economies (EMDEs) had to endure to protect themselves against the risks of financial globalization. In addition, the study estimates the cost of excess reserves in emerging market economies (EMEs) using various reserve adequacy indicators that reflect potential sources of foreign exchange drains and vulnerability in EMEs' balance of payments.Design/methodology/approachThis paper begins by explaining the accumulation of foreign reserves in EMDEs as a self-protection strategy against the risks of financial globalization. Next, it sheds light on the different types of economic costs of foreign reserve accumulation. Finally, it estimates the cost of foreign reserve accumulation in EMEs during the period (1990–2018) and in EMDEs during the period (1990–2015) due to data availability.FindingsResults indicate that the cost of accumulating foreign reserves as a self-protection strategy in EMDEs and EMEs' was huge compared to their development financing needs. Applying various reserve adequacy measures demonstrates that many of the EMEs were holding inadequate precautionary reserves in 2018. Actually, this reflects the significant increase in external short term debt that many of the EMEs have witnessed since the eruption of the global financial crisis (2008). Thus increasing reserves in EMEs with weak reserve buffers and higher external debt is critical as they are more vulnerable to external shocks and capital flow reversals. Also given the estimated huge costs of accumulating foreign reserves, EMDEs should accompany it by other complementary self-protection policies and liquidity management policies to free up resources for productive investment.Originality/valueThe study contributes to the literature by estimating the cost of precautionary foreign reserve accumulation imposed on EMDEs during an extended period of time that covers a decade after the onset of the global financial crisis. Also to the authors' knowledge, this is the first study that estimates the cost of excess reserves in EMEs using various reserve adequacy indicators including the International Monetary Fund (IMF) assessing reserve adequacy (ARA) approach.

Liquidity risk, market power and the informational effects of policy

Using a structural approach, we combine bidding data from open market operations with macroeconomic information to recover the latent distribution of liquidity risk across financial institutions in Chile and how it is affected by policy. We find that unanticipated shocks to foreign reserve accumulation and interest rates have significant effects on aggregate beliefs about a liquidity shock in the near future. We demonstrate that accounting for market power is important for measuring the strength of this informational channel of macroeconomic policy.

Monetary policy autonomy and foreign reserves accumulation in Brazil: a compensation view

AbstractDuring the 2000s, Brazil accumulated a substantial amount of foreign reserves through foreign exchange market interventions undertaken by its Central Bank. Mainstream economics considers such interventions a restriction to monetary policy autonomy. This article analyses the relationship between monetary policy autonomy and exchange rate regimes theoretically and empirically for the Brazilian economy. We argue that the compensation principle, as a direct derivation of the endogenous money approach, is an alternative to both the trilemma and dilemma views in the mainstream perspective. Then, we provide empirical evidence in favour of the compensation principle in the Brazilian economy by verifying the exogeneity of the interest rate and estimating a vector error-correction model (VECM) that indicates that the foreign reserves do not have a long-term effect on the monetary base, while they present a significant and large effect on the repos account. In line with the compensation view, we conclude that in the 2000s, Brazil had more monetary policy autonomy than conventional approaches would have suggested.

Modelling Foreign Exchange Interventions under Rayleigh Process: Applications to Swiss Franc Exchange Rate Dynamics.

This paper models the foreign exchange intervention policy following the Rayleigh process derived from the standard flexible-price monetary framework. The exchange rate dynamics associated with the interventions are more sensitive to the change in the economic fundamental when a currency’s money supply is ample and its appreciation expectation cannot be offset by lower interest rates that have fallen to the zero lower bound, suggesting that more intensive interventions are required to counteract currency appreciation pressure and resulting in foreign reserve accumulation. The empirical results using market data during January 2015–February 2020 demonstrate that the model can describe the dynamics of the Swiss franc exchange rate. The accumulation of foreign reserves through interventions is negatively co-integrated with the exchange rate volatility and the value of the mean level of the Swiss franc exchange rate in the dynamics, to some extent indicating a reasonably high degree of effectiveness of the Swiss National Bank’s interventions. The transition between the target-zone and floating-rate regimes in 2015 caused changes in the level of exchange rate volatility but not its dynamical structure, suggesting that transitions between the floating-rate and target-zone regimes do not seem to have material consequence in this regard.

Determinants of International Reserves in Nigeria

Over the past decades, nations have accumulated international reserves to leverage foreign counterparts or protect themselves against external shocks resulting from integration. The factors identified by researchers as contributing to international reserve accumulation, however, have primarily been market factors. This study sets out to identify some distinct factors of the Nigerian economy. This is accomplished using annual data from 1970 to 2016. Several econometric methods, including the unit root test and Granger causality, were applied to test two hypotheses. The results showed substantial long-run correlations between the variables examined. Thus, the Error Correction Methodology (ECM) was used to investigate short-term and long-term relationships. Findings reveal that the accumulation of foreign reserves was significantly influenced in the long run only by aggregate exports EXPT and trade openness OPN since both variables were statistically significant at 5 percent. At the specified beak-point, there was an important structural change. Finally, Nigeria’s level of international reserves was significantly impacted by the quality of its institutions. Thus, the study recommends that policymakers maintain the current exchange rate regime in order to ensure world competitiveness. The research also suggested that the government take steps to improve and build strong institutions in order to promote transparency and accountability.

A Macroprudential Theory of Foreign Reserve Accumulation

This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the recent upward trend in international reserves.

THEORETICAL ANALYSIS OF THE EVOLUTION OF MONETARY SYSTEMS OF RUSSIA IN EXTREME MILITARY-POLITICAL CIRCUMSTANCES OF THE FIRST HALF OF THE TWENTIETH CENTURY (IN CONNECTION WITH THE 80TH ANNIVERSARY OF THE BEGINNING OF THE GREAT PATRIOTIC WAR)

The author of the article, addressed to those who teach and study in higher education economic theory, the history of economic thought and the socio-economic history of Russia, proceeds from the premise that changes in the socio-economic system of the country during the period of change in the dominant technological order actualize the development of the theory of money and the study of various stages of historical evolution of the domestic monetary economy (Russian monetary systems). In this context, an analysis of those periods of this evolution in the first half of the twentieth century, when the credit ruble becomes an extraordinary resource of the «war economy», unfolds. The article also examines the peculiarities of monetary circulation during the operation of the gold standard system and during the period of gold «leaving» to the state reserve fund. The author puts forward a hypothesis according to which the changes taking place in the monetary system in connection with the demonetization of gold are the accumulation of prerequisites for the transition to a post-industrial economic system.
 
 Inclusion in the analysis of the events of the global military-political history of 1914–1917 and 1941–1945, i.e. events of the First and Second World Wars, helps to reveal the real basis on which a special type of economic relations was formed — the phenomenon of «war economy». The article identifies the key factors of instability in the twentieth century — industrial, monetary and world crises. The study of the peculiarities of the development of the crisis in peacetime and in the conditions of a «military-inflationary economy» in the works of prominent Russian economists deepens the understanding of the structural deformation of the national economy.
 
 It is shown that the «price revolution», which characterizes the explosive growth of inflation, has become a vivid manifestation of the world economic instability during the development of extreme military-political events in Russia and in the countries of Western Europe. Attention is drawn to the fact that the «price revolution» in the conjuncture theory of M.I. Tugan-Baranovsky and the works of Z.S. Katsenelenbaum was considered as a function of qualitative changes that took place in the economic system as a result of the expansion of the sphere of money circulation during the transition from natural production to industrial production. The «price revolution» manifested itself with the greatest force in the conditions of the «war economy». The destruction of the national economy was accompanied by the development of «golden» inflation, indicating a chronic commodity deficit.
 
 The author argues that the size of the accumulation of gold in 1920–1945, the emergence of large banks — custodians of the gold and foreign exchange reserves of the countries — members of the monetary unions — largely influenced the results of the competition between the three leading currencies (franc, pound and dollar), claiming to be the world leader. The conclusion is argued that the accumulation of gold and foreign exchange reserves in the conditions of the «war economy» accelerated the formation of a new monetary and financial «map» of the world in the second half of the twentieth century.

Endogenous corporate leverage response to a safer macro environment: The case of foreign exchange reserve accumulation

A country may adopt policy measures such as raising its foreign exchange reserves to better prepare for sudden reversal of international capital flows or currency attacks, which in principle should reduce financial vulnerability for its firms and the entire economy, but the beneficial effect of such policies may be partially offset by endogenous firms' decisions to take on more risks. We present a robust but previously undocumented relationship between corporate leverage and country-level foreign exchange reserve holdings. For 6610 non-financial firms in 23 emerging markets from 2000 to 2006, we show that more foreign reserve accumulation leads to higher corporate leverage. The effect is significantly greater in sectors that are intrinsically more sensitive to uncertainty. We go from correlation to causality via a two-prong instrumental variable strategy: simultaneously (1) instrumenting FX reserves by global commodity price movement, and (2) examining leverage of firms outside the commodity-sensitive sectors.

Managed exchange rate regimes and monetary independence: an empirical appraisal

ABSTRACT Under the impossible trinity, it is alleged that attempts to maintain both monetary independence and an undervalued domestic exchange rate whilst being exposed to global capital flows will culminate in macroeconomic instability. To analyse the validity of the impossible trinity in the instance of a balance of payments surplus, we first employ a number of ARDL models to investigate the potential presence of co-integration between foreign reserves and several variables on the balance sheet of the Central Bank. A VECM is then used to exemplify the fact that policymakers must respond to an increase in foreign reserves so as to steer the interbank rate to the policy rate. In total, we argue that in the case of a balance of payment surplus (i) it is problematic to validate the existence of a transmission mechanism between foreign reserve accumulation and inflation; (ii) economies with heavily managed exchange rates appear to have achieved monetary independence whilst remaining open to global capital flows; and finally, (iii) since the four Central Banks examined target an overnight rate, rather than any form of monetary aggregate, ‘exogenous’ sterilisation initiatives are involuntary.

Foreign reserve accumulation, foreign direct investment, and economic growth

This paper develops a quantitative small-open-economy model to study the determinants of the optimal pace of foreign reserve accumulation by developing countries. In the model, reserve accumulation depreciates the real exchange rate and attracts foreign direct investment (FDI) inflows, which promotes productivity growth through endogenous firm dynamics. The economy is also subject to sudden stops in the form of an occasionally binding constraint on foreign borrowing, and accumulated reserves are used to prevent severe economic downturns. The model shows that two factors are the key determinants of the optimal pace of reserve accumulation: the elasticity of the foreign borrowing spread with respect to foreign debt and the entry cost for FDI. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation.

The Size and the Main Determinants of China’s Official Currency Reserves in the Period 1990-2019

Purpose: This paper aims to analyze the size of China's Central Bank's foreign exchange reserves and the main determinants of changes in China's foreign reserves. The publication attempts to prove two theses. According to the first thesis, the current foreign exchange reserves level in China has been higher than the optimal level suggested by the foreign exchange reserves adequacy ratios. However, in line with the second thesis, the most important factors determining China's foreign exchange reserves were changes in the value of imports and changes in the level of China's short-term foreign debt. Design/Methodology/Approach: The study uses a research method based on literature studies in the field of banking and international finance and econometric methods (the classic least squares method). The selection of these research methods and their use are elements of the author's approach to the problem of the optimal level of foreign exchange reserves in China. Findings: Research revealed that for almost the entire period 1990-2019, the value of China's foreign exchange reserves was higher than the optimal values, as suggested by the adequacy ratios of currency reserves. The exceptions were the ratio of the optimal level of foreign exchange reserves, calculated as 20% of the M2 money supply, and the ratio calculated by the IMF methodology for countries with constant exchange rates. China's relatively high foreign exchange reserves were adequately hedged against the possible effects of economic crises, while the relatively high level of these reserves led to their low profitability. The analysis results indicated that changes in the value of China's foreign exchange reserves were, to the greatest extent, determined by the inflow of foreign direct investment and changes in import expenditure. Practical Implications: The discussion on the accumulation of foreign reserves should have practical implications and be set to eliminate threats, not to individual economies but to maintain global financial stability in the world. On the other hand, the currency reserves adequacy indicators themselves should be used flexibly and should reflect individual countries' economic specificities. Originality: So far, no such comprehensive research has been carried out on the magnitude and determinants of China's foreign reserves changes. What is more, the analysis covers a long period of research (1990-2019) and is based on the proprietary model, estimated with the use of econometric tools.

International Effects of Quantitative Easing and Foreign Reserve Accumulation

In this paper, I develop a two-country general equilibrium model with financial frictions to study the global consequences of quantitative easing (QE) and foreign exchange reserve accumulation. In the model, the key financial frictions are limited commitment and differential pledgeability of collateral, and due to these frictions, the scarcity of collateralizable assets matters. Financial intermediaries have differential and asymmetric pledgeability of assets as collateral and acquire different asset portfolios depending on their home country. QE can reduce long-term bond yields and term premia internationally and depreciate the relatively high-collateral-scarcity currency. Foreign reserve accumulation always depreciates the local currency, but it improves welfare globally if implemented by the high-collateral-scarcity country.

Forecasting the implications of foreign exchange reserve accumulation with a microsimulation model

ABSTRACT We develop a stock-flow-consistent microsimulation model that comprises all relevant mechanisms of money creation and parametrise it to fit actual data. The model is used to make out-of-sample projections of broad money and credit developments under the commencement/termination of foreign reserve accumulation by the Bank of Russia. We use direct forecasts from the miscrosimulation model as well as the two-step approach, which implies the use of artificial data to pre-train the Bayesian vector autoregression model. We conclude that the suggested approach is competitive in forecasting and yields promising results.

What is Slowing Growth in China?

A small part of the slowdown of growth in China in the recent decade may be due to the decline in population growth. The major factor contributing to China’s growth slowdown has been the reversal of earlier policies resulting in foreign exchange reserve accumulation. The resulting pressure for the currency to appreciate undermined the international competitiveness of Chinese exports. This has led to the decline in China’s export/GDP and investment/GDP ratios besides reorienting growth towards domestic consumption, thus also reducing household savings.

Foreign Exchange Dynamics and Reserve Accumulation under Capital Inflows

When a currency’s appreciation expectation cannot be offset by lower interest rates which have fallen to the zero lower bound, the monetary authority needs to intervene to prevent currency appreciation due to capital inflows and resulting in foreign reserve accumulation. Based on a standard flexible-price monetary framework, this paper extends a target-zone model in which the intervention policy is incorporated by specifying the asymmetric mean-reverting fundamental dynamics with the smooth-pasting condition at a moving boundary. The solution of the model shows that the exchange rate dynamics is more sensitive to the change in the fundamental when the domestic interest rate is constrained at zero, suggesting more intensive interventions are required to counteract currency appreciation pressure. The empirical results using market data during January 2015 – February 2020 demonstrate that the model can describe the dynamics of the Swiss franc exchange rate following the mean-reverting square-root process. The accumulation of foreign reserves through interventions is negatively co-integrated with the exchange rate volatility and the value of the mean level of the Swiss franc exchange rate in the dynamics, to some extent indicating a reasonably high degree of effectiveness of the Swiss National Bank’s interventions.

Optimal Foreign Reserves and Central Bank Policy Under Financial Stress

We study the interaction between optimal foreign reserves accumulation and central bank international liquidity provision in a small open economy under financial stress. Firms and households finance investment and consumption by borrowing from domestic financial intermediaries (banks), which in turn borrow from abroad. Binding financial constraints can cause the domestic rate of interest to rise above the world rate and the real exchange rate to depreciate, leading to inefficiently low investment and consumption. A role then emerges for a central bank that accumulates reserves in order to provide liquidity if financial frictions bind. The optimal level of international reserves in this context depends, among other variables, on the term premium, the depth of financial markets, ex ante financial uncertainty and the precise way the central bank intervenes. The model is consistent with both the increase in international reserves observed during the period 2004-2008 and with policy intervention after the Lehman bankruptcy. Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

The distortionary effects of sterilised reserve accumulation on domestic credit markets: Evidence from Uganda

Some small open Least Income Countries embarked on rapid accumulation of foreign reserves in the wake of volatile capital inflows. Foreign reserve accumulation is one way of managing volatile capital flows. However, rapid and persistent accumulation is not only costly, but potentially distort the domestic financial markets, especially when it is financed by sterilisation. This study investigates the potential distortions on commercial bank lending in Uganda. Our empirical results show that sterilised reserve purchases crowd-out bank lending. The crowding-out effect is persistent even when bank capitalisation and shifts in monetary policy regimes are controlled for, which raise important policy implications. The objective of sterilisation is to maintain the prevailing stance of monetary policy. However, when it alters the prevailing stance of monetary policy and consequently the direction of the impact of policy as the empirical result has shown, then sterilised reserve purchases violate the “impossible trinity” i.e. it weakens the monetary authority's control over domestic monetary conditions.