Level Of International Reserves Research Articles

Surfing the Waves of Globalization: Asia and Financial Globalization in the Context of the Trilemma

Using the “trilemma indexes” developed by Aizenman et al. (2008) that measure the extent of achievement in each of the three policy goals in the trilemma — monetary independence, exchange rate stability, and financial openness — this paper examines how policy configurations affect macroeconomic performances with focus on the Asian economies. We find that the three policy choices do not matter for per capita economic growth. However, they do matter for output volatility and the medium-term level of inflation. Greater monetary independence is associated with lower output volatility while greater exchange rate stability implies greater output volatility, which can be mitigated if a country holds international reserves (IR) at a higher level than a threshold (about 20% of gross domestic product). Greater monetary autonomy is associated with a higher level of inflation while greater exchange rate stability and greater financial openness could lower the inflation level. We find that trilemma policy configurations and external finances affect output volatility mainly through the investment channel. While a higher degree of exchange rate stability could stabilize the real exchange rate movement, it could also make investment volatile, though the volatility-enhancing effect of exchange rate stability on investment can be cancelled by holding higher levels of IR. Greater financial openness helps reduce real exchange rate volatility. These results indicate that policy makers in a more open economy would prefer pursuing greater exchange rate stability and greater financial openness while holding a massive amount of IR. Asian emerging market economies are found to be equipped with macroeconomic policy configurations that help the economies to dampen the volatilities in both investment and real exchange rate. These economies’ sizeable amount of international reserves holding appears to help enhance the stabilizing effect of the trilemma policy choices, which explains the recent phenomenal buildup of international reserves in the region.

International reserves and monetary policy

We present a model that determines both monetary policy and level of international reserves. Strict monetary policy would build precautionary reserves that allow future monetary policy to better stabilize inflation and output and lower the likelihood of forthcoming financial crisis.

International Reserves in Emerging Market Countries: Too Much of a Good Thing?

International Reserves in Emerging Market Countries:Too Much of a Good Thing? Olivier Jeanne With International reserves four times as large, in terms of their GDP, as in the early 1990s, emerging market countries seem more protected than ever against shocks to their current and capital accounts. Some have argued that this buildup in reserves might be warranted as insurance against the increased volatility of capital flows associated with financial globalization.1 Others view this development as the unintended consequence of large current account surpluses and suggest that the level of international reserves has become excessive in many of these countries.2 [End Page 1] Do emerging market countries hold too much international reserves, and are there better ways to use those funds? Answering these questions requires a normative benchmark for the optimal level of reserves. I present in this paper a simple welfare-based model of the optimal level of reserves to deal with the risk of capital account crises or of "sudden stops" in capital flows. On the basis of this model, I derive some formulas for the optimal level of reserves and compare them with conventional rules of thumb, such as the Greenspan-Guidotti rule of full coverage of short-term debt. I then calibrate the model for emerging market countries and compare its predictions with the actual data. One lesson from this exercise is that the optimal level of reserves is subject to considerable uncertainty, because it is sensitive to certain parameters that are difficult to measure. The model nevertheless produces ranges of plausible estimates against which the data can be compared. I find that it is not difficult for the model to explain a reserves-GDP ratio on the order of 10 percent for the typical emerging market country (close to the long-run historical average), and that even higher ratios can be justified if one assumes that reserves have a significant role in crisis prevention. The levels of reserves observed in many countries in the recent period, in particular in Latin America, are within the range of the model's predictions. Ultimately, however, the insurance model fails to account for the recent pattern of reserves accumulation in emerging market countries. The reason is that most of the reserves accumulation has taken place in Asian emerging market countries, where the risk of a capital account crisis seems much too small to justify such levels of self-insurance. The insurance model can account for the reserves accumulation observed in the Asian emerging market countries only if one assumes that the expected cost of a capital account crisis is unrealistically large (more than 60 percent of GDP for one of the two major types of crisis examined). The conclusion that most of the current buildup of reserves is not justified by precautionary reasons has some implications for reserves management. There is little reason for countries to invest these funds in the liquid but low-yielding foreign assets in which central banks tend to invest. Rather, reserves should be viewed as a component of domestic external wealth that is managed by the public sector on behalf of the domestic citizenry, taking full advantage of the portfolio diversification opportunities available abroad. Indeed, an increasing number of emerging market countries [End Page 2] are transferring a fraction of their reserves to "sovereign wealth funds," mandated to invest in a more diversified way and at a longer horizon than central banks normally do. This is a trend that might take on considerable importance looking forward. The last part of the paper discusses some policy challenges and opportunities implied by the buildup in emerging market countries' "sovereign wealth." I discuss, first, the impact of sovereign wealth diversification on global financial markets, and second, some ways in which this wealth could be used in collective international arrangements—to insure against future crises or to promote financial development. The Buildup in International Reserves The growth in the international reserves of emerging market countries is striking when compared with the contemporaneous trends in reserves in industrial countries (figure 1).3 Whereas reserves in a group of industrial countries have remained stable below 5 percent of GDP, reserves in the emerging market countries have grown more...

An empirical examination of exchange-rate credibility determinants in the EMS

This study provides empirical evidence on the determinants of exchange rate credibility under the European Monetary System (EMS). To that end, it considers both economic variables and political factors using data of eight currencies participating in the Exchange Rate Mechanism, covering the complete EMS history (1979 to 1998). The results suggest that the level of international reserves, the real interest rate and right-wing governments would have positively affected the credibility of a given central parity, while the unemployment rate and the inflation rate would have negatively influenced such credibility.

Currency Crises and Political Factors: Drawing Lessons from the EMS Experience

AbstractThis paper analyses the functioning of the European Exchange RateMechanism (ERM). To that end, we apply duration models to estimatean eclectic specification that enables us to explicitly incorporated politicaland institutional factors into the explanation of European exchange ratepolicies. The estimations are based on quarterly data of eight currenciesparticipating in the ERM, covering the complete history of the EuropeanMonetary System. Our results suggest that both economic and politicalfactors are important determinants of the ERM currency policies. Con-cerning economic factors, the real exchange rate, the interest differentialsand the central parity deviation would have negatively affected the dura-tion of a given central parity, while credibility, the level of internationalreserves and the price level in the anchor country would have positivelyinfluenced such duration. Regarding political variables, elections, centralbank independence and left-wing administrations would have increasedthe probability of maintaining the current regime, while unstable govern-ments would have been associated with more frequent regime changes.Moreover,weshowhowthepoliticalaugmented model outperforms, bothin terms of explanatory power and goodness of fit, the model which justincorporates pure economic determinants.JEL classification numbers: C41, D72, F31, F33Key Words: Duration analysis, Political variables, Exchange rates, Eu-ropean Monetary System

An Empirical Examination of Exchange-Rate Credibility Determinants in the EMS

This paper provides empirical evidence on the determinants of exchange rate credibility under the European Monetary System (EMS). To that end, we have considered both economic variables and political factors using data of eight currencies participating in the Exchange Rate Mechanism, covering the complete EMS history (1979-1998). Our results suggest that the level of international reserves, the real interest rate and right-wing governments would have positively affected the credibility of a given central parity, while the unemployment rate and the inflation rate would have negative influenced such credibility.

How Should Emerging Economies Manage their Foreign Exchange Reserves?

Asia has emerged as the balancing wheel of global finance. The countries of Asia now account for 70 per cent of global foreign exchange reserves, compared to only 30 per cent in 1990 and 21 per cent in the early 1970s. This paper explores theoretical interpretations for the relatively high demand for international reserves by developing countries especially in the Far East. This paper provides calculations of the minimal necessary level of international reserves based on benchmarks proposed by Wijnholds and Kapteyn, as well as a discussion of costs of reserves' holding. It therefore provides empirical proof that exchange reserve levels for many of the developing countries have far exceeded the desirable levels. Paper then discusses the steps that central banks in these developing countries can take for an effective reserve management.

Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops

In this paper I analyze the anatomy of current account adjustments in the world economy during the past three decades. The main findings may be summarized as follows: (i) Major reversals in current account deficits have tended to be associated with “sudden stops” of capital inflows. (ii) The probability of a country experiencing a reversal is captured by a small number of variables that include the (lagged) current account to GDP ratio, the external debt to GDP ratio, the level of international reserves, domestic credit creation, and debt services. (iii) Current account reversals have had a negative effect on real growth that goes beyond their direct effect on investments. (iv) There is persuasive evidence indicating that the negative effect of current account reversals on growth will depend on the country's degree of openness. More open countries will suffer less-in terms of lower growth-than countries with a lower degree of openness. (v) I was unable to find evidence supporting the hypothesis that countries with a higher degree of dollarization are more severely affected by current account reversals than countries with a lower degree of dollarization. And (vi) the empirical analysis suggests that countries with more flexible exchange rate regimes are able to accommodate the shocks stemming from a reversal better than countries with more rigid exchange rate regimes.

An Eclectic Approach to Currency Crises: Drawing Lessons from the EMS Experience

This paper examines the regime changes in the European Exchange Rate Mechanism (ERM), by applying the duration model approach to quarterly data of eight currencies participating in the ERM, covering the complete European Monetary System (EMS) history. We first make use of the nonparametric (univariate) analysis, finding that the probability of maintaining the current regime decreases very rapidly for the short durations to register then smoother variations as time increases. Second, we apply a parametric (multivariate) analysis to investigate the role of other variables in the probability of a regime change. In particular we consider three alternative theoretical frameworks to select potential explanatory variables: First- and second-generation models of currency crisis and an eclectic model that combines the explanatory variables suggested by both models. Our results suggest that the Weibull specification of the eclectic model would be the more appropriate to fit our data set, finding that the real exchange rate, the interest differentials and the central parity deviation would have negatively affected the duration of a given regime, while credibility, the level of international reserves and the price level in the anchor country would have positively influenced such duration. Finally, we do not find evidence of observed heterogeneity associated to currencies with different behaviour in the sample, nor the existence in our sample of unobserved heterogeneity caused either by misspecification or omitted covariates.

A dynamic optimal investing model for international reserves management

The major purpose of this paper is to determine the optimal investing path and the stock level of international reserves by applying dynamic optimization approach on analyzing the investment behavior so that the total returns are maximized. It constructs an international reserves investing plan (lRIP) model that provides an attention to the actively precautionary motive of holding international reserves under the consideration of opportunity cost in investing action. In addition, sensitivity analyses for the key variables of optimal solution are also provided. Accordingly, this paper represented a dynamic investment philosophy of managing international reserves fur a country’s monetary authority with great reference.

Why do countries float the way they float?

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities to the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or on interest rates. We document these differences and explore potential causes that have been suggested by the recent theoretical literature. In particular, we explore the role of the pass-through of exchange rate movements into prices and the consequences of currency mismatches in balance sheets, which we associate to a country's ability to borrow internationally in its own currency. We find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find little evidence of the importance of pass-through to account for differences across countries with respect to their exchange rate/monetary management.

The Empirics of Foreign Reserves

In this article, we study the determinants of cross-country variation in the level of international reserves over the period 1981–1995. Confirming intuition, trade openness is easily the most important variable. There is also some evidence that financial deepening is associated with an increase in the reserves ratio. Smaller and more volatile industrial countries hold larger reserves than their larger, less volatile counterparts. In addition, more indebted developing countries tend to have smaller reserve ratios. We view these results as establishing some interesting stylized facts that may be helpful in informing future theoretical modeling of reserves behavior.

Banks, debt maturity and financial crises

We develop a model in which the maturity of external debt of banks, their level of international reserves, and the term structure of interest rates are jointly determine. Self-fulfilling runs may occur, and banks take this possibility into account when choosing the structure of their assets and liabilities. If the probability of a run is sufficiently small banks will deliberately choose an illiquid asset-liability position and expose themselves to a run. In that case, short term debt will be cheaper than long term debt, and the maturity structure of foreign debt will depend on attitudes towards risk.

Why Do Countries Float the Way They Float?

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities to the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or on interest rates. We document these differences and present a model that explains them as the optimal response of a Central Bank that attempts to minimize a standard loss function, in an environment in which firms are credit-constrained and incomplete markets limit their ability to avoid currency mismatches. This model suggests that the difference in the way countries float cold be related to their differing levels of exchange rate pass-through and the differing ability to avoid currency mismatches. We test these implications and find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find weaker and less robust evidence on the importance of pass-through to account for differences across countries with respect to their exchange rate/monetary management.

Why Do Countries Float the Way They Float?

Countries that are classified as having floating exchange rate systems (or very wide bands) show strikingly different patterns of behavior. They hold very different levels of international reserves and allow very different volatilities in the movements of the exchange rate relative to the volatility that they tolerate either on the level of reserves or in interest rates. We document these differences and present a model that explains them as the optimal response of a Central Bank that attempts to minimize a standard loss function, in an environment in which firms are credit-constrained and incomplete markets limit their ability to avoid currency mismatches. This model suggests that the difference in the way countries float could be related to their differing levels of exchange rate pass-through and differences in their ability to avoid currency mismatches. We test these implications and find a very strong and robust relationship between the pattern of floating and the ability of a country to borrow internationally in its own currency. We find weaker and less robust evidence on the importance of pass-through to account for differences across countries with respect to their exchange rate/monetary management.

The Effect of Various Credit Controls on the Level of International Reserves

Die Wirkung verschiedenartiger Kreditkontrollen auf das Niveau der internationalen Reserven In diesem Aufsatz werden die Wirkungen unterschiedlicher Arten der Geld- und Kreditpolitik auf das Niveau internationaler Reserven analysiert und bewertet. Als Instrumente zur Kontrolle und Stabilisierung ihrer Zahlungsbilanz verwenden die meisten weniger entwickelten Länder Plafonds für die vom Bankensystem gewährten Kredite sowie Vorauszahlungen für Importe. Dieser Aufsatz zeigt, daß für die Kontrolle der internationalen Reserven inländische Kreditkontrolle seitens der Zentralbank (einschließlich des Instruments der Vorauszahlungen für Importe) wirksamer ist als das Plafondieren der Kreditgewährung privater Geschäftsbanken.

A note on balance of payments deficits, the adjustment cost and the optimum level of international reserves

A note on balance of payments deficits, the adjustment cost and the optimum level of international reserves

Balance of payments deficits, the adjustment cost and the optimum level of international reserves: A reply

Balance of payments deficits, the adjustment cost and the optimum level of international reserves: A reply

Free Floating and the Emerging Dollar Standard

For several years the problem of international monetary reform has been discussed ad nauseam in terms of:— convertibility of «overhang» dollar balances— the supply of an «adequate» level of international reserves and the official price of gold— the selection of a regime of exchange rates.However, little new thought has been given to the issue of what it is that the exchange rate is supposed to measure and what it is that a regime of international payments is supposed to accomplish.Instead, in most discussions, implicitly or explicitly, it has been taken for granted that there must be some set of «equilibrium exchange rates» for which international trade flows and welfare are somewhat optimized.

A Monetary Budget

THE DRAWING UP OF BALANCE SHEETS for the monetary system1 has received increasing attention in many countries during the past few years. These balance sheets are particularly useful in helping to make short-term projections-which might be described as Monetary Budgets-that will indicate the monetary developments likely to accompany probable future fiscal and balance of payments experiences. The purpose of this paper is to illustrate, by reference to a hypothetical example, the practical usefulness of such a projection. The illustration proceeds by means of tables arranged in balance sheet form. The figures have no relation to the data of any actual country; they are no more than materials with which to demonstrate methods of working. It should also be said that the example has been simplified, and that many of the problems that exist in such work in real life have been omitted, in order to keep the illustration from becoming too lengthy. The main elements needed in an exercise of this kind are patience and arithmetic. For the purpose of the exercise, we imagine that we are in the Research Department of a Central Bank, and that we have been instructed to examine the monetary prospects for the coming fiscal year, say 1958-59, giving special attention to the measures needed to end the domestic price inflation that has been a constant source of trouble in the past few years. The low level of international reserves has also caused continual concern and has led to the erection of a complex structure of strict controls on international trade. It is hoped that the establishment of domestic price stability may be a first step toward easing and eliminating the restraints on trade. At the moment, the level of unemployment gives no particular cause for concern. The first step is to review the performance of the banking system in the past few years, and for this purpose Tables IA, IB, and IC are