Official Reserves Research Articles

Market Timing and Performance Attribution in the ECB Reserve Management Framework

We study the performance of a group of foreign exchange reserve managers that are responsible for investing the ECB’s official reserves in US dollars, for a value of around $43 billion, using a new dataset which includes detailed portfolio holdings from 2006 to 2010. The ECB reserve managers display a positive ability at security selection overall. Two portfolio managers show market timing ability after adjusting for the non-linearity of the benchmark returns. For one portfolio manager, market timing ability is significantly related to the efficient use of public information. To pin down market timing, we develop a performance attribution model which identifies the contribution of the key portfolio managers’ strategies (duration, curve, and spread). We find that, among the active layers, the spread contribution seems the most significant; curve and duration bets, with some exceptions, have generally provided little value added. Our analysis supports the view that portfolio managers adopt diversified investment styles. This may explain the non-negligible result of the aggregate reserve portfolio, averaging 10 basis points on an annual basis, net of transaction costs. The more diversified the investment styles are, the more likely it is that portfolio managers make independent bets, which in turn may positively affect the risk-adjusted return of the aggregate portfolio.

The Effects of US Unconventional Monetary Policies in Latin America

This paper offers an empirical analysis of the way in which US unconventional monetary policy has affected Latin American countries. First, we estimate the effects of US monetary policy announcements on sovereign bond interest rates, exchange rates and stock market indices for a set of emerging countries, including five Latin American economies. We find that QE announcements in 2008/2009 and the “tapering talk” in 2013 generated sizable sovereign yield and exchange rate fluctuations. We further find some excess response of Latam asset prices that disappear once we take into account their country characteristics. In the second part of the paper we estimate a simple model that measures the influence of country-specific macroeconomic fundamentals on the transmission of US financial disturbances. An estimated model including the inflation rate, the CDS spread, the ratio of official reserves and market capitalisation explains some of the observed cross-country heterogeneity of spillovers from US monetary policy announcements. Under this model, a greater impact from the normalisation of US monetary policy can be expected in Latin America relative to other emerging economies.

Will the Renminbi Devalue?

The Renminbi surprised the World markets by its unexpected devaluations first in August 2015 and then in January 2016. Will the Renminbi devalue again? In this paper, the questions of whether the Renminbi is over-valued, whether the level of Chinese official foreign exchange reserves is adequate, and whether a devaluation is in the best interests of China are considered. The paper also discusses the risks faced by the Renminbi. But the most important consideration is how the confidence of the Chinese people in the Renminbi, which depends on whether it retains its purchasing power, both domestic and overseas, can be credibly maintained. The conclusion of this paper is that the Renminbi is unlikely to devalue abruptly and significantly going forward, even though there may be small fluctuations in the Renminbi exchange rate.

The Real Exchange Rate and Economic Growth: Revisiting the Case Using External Instruments

We investigate the impact of movements in the real exchange rate on economic growth based on five-year average data for a panel of over 150 countries in the post Bretton Woods period. Unlike previous literature, we use external instruments to deal with possible reverse causality from growth to the real exchange rate. Our country-specific instruments are (i) global capital flows interacted with individual countries financial openness and (ii) the growth rate of official reserves. We find that a real appreciation (depreciation) reduces (raises) significantly annual real GDP growth, more than in previous estimates in the literature. However, our results confirm this effect only for developing countries and for pegs.

Currency composition of reserves, trade invoicing and currency movements

This article analyses the relationships among the unit of account and means of exchange functions of an international currency, on the one hand, and its store of value in official use, on the other hand. Historical evidence links the currency composition of reserves to currency movements. The currency composition of reserves is strongly related in the cross-section to both currency movements and the currency denomination of trade. Data limitations make it hard to distinguish these two factors. A panel analysis of 5 countries from central and Eastern Europe shows that both trade invoicing and currency movements drive changing official reserve composition. Implications are suggested for the prospects for the renminbi enlarging its current small portion of official foreign exchange reserves.

The Future of the Euro Still Lies in its Past

The true problem for the future of the Euro is to get a wider statute for the European Central Bank (ECB) similar to those of other central banks, notably the Fed, to permit better monetary policy. This means the power to act as a lender of last resort or “whatever it takes” (Draghi 2012). People consider this possibility tied to the political will of the main member states (Germany and the Netherlands, partly France). However, two other problems would remain unresolved if the Euro is to have full legitimacy as a paper money: a state behind it and a common Eurozone fiscal policy. This means a move to a political union, which is less possible than the approval of a new ECB statute. The existence of these problems does not mean that the Euro cannot survive, but that it depends on the will of both the market and the owner of official reserve denominated in Euro. It also depends on acceptance by member countries affected by the negative effects of not having a true and free lender of last resort and a targeted policy to resolve the weakness of the non-optimal currency area of the Eurosystem which preexisted the birth of the Euro. This is why the future of the Euro still lies in its past, not having found a consensus on what to do or leaders capable of filling the gap. Collapse is always possible.

The need for official reserves in Latin America: assessing the precautionary motive, 1995-2011

In this paper we estimate the demand for official reserves in Latin America during the period 1995-2011. We assume that the main concern of the monetary authorities to demand reserves is the fear of suffering external drains, and its associated output costs. In other words, we attempt to show that the so-called precautionary motive drives the demand for international reserves in the region. Our econometric results confirm that Latin American countries demand ever increasing amounts of foreign exchange to protect themselves against the likelihood of external drains.

Foreign exchange reserve diversification and the “exorbitant privilege”: Global macroeconomic effects

We assess the macroeconomic implications for the global economy of different strategies of official reserve management by developing a large scale new-Keynesian dynamic general equilibrium model, calibrated to the euro area, the United States, China and the rest of the world. An increase in the global demand for euros would boost euro area aggregate demand because of the reduction in euro area interest rates (the main benefit associated with the “privilege” of being a global currency). If the higher demand for euros is associated with lower demand for US dollars, then US aggregate demand falls because of higher interest rates, while the external balance improves; countries accumulating reserves continue to run a trade surplus, as exports to the euro area increase. We also compute welfare gains/costs for all economies.

Reforming the International Monetary System in the 1970s and 2000s: Would a Special Drawing Right Substitution Account Have Worked?

AbstractAdvocates of a more pluralistic international monetary and financial system seek to reduce reliance on a single national currency and to bring international liquidity under collective control. One recently revived proposal would transform US dollar official reserves into claims denominated in the IMF's key currency basket, Special Drawing Rights (SDRs). Drawing on new archival evidence and simulations, this article highlights issues that derailed earlier agreement on such an account and shortcomings of design and ambition revealed by subsequent developments. One design issue was account losses if US dollar yields failed to exceed SDR yields enough to offset dollar depreciation. In fact, uncovered interest parity did not hold and could well have left the account persistently insolvent. Another shortcoming was ambition: the proposed account proved simply too small to achieve the desired lowering of the dollar's share of foreign exchange reserves. Any new proposal needs to address these shortcomings.

Excessive bird collecting in Malawi: a new threat

SummaryMalawi is under heavy pressure for land by an increasing human population, and there is little natural habitat left outside gazetted wildlife and forest reserves. Widespread collecting of birds in Malawi’s small protected rain forests by the National Museum of Malawi in conjunction with Western academic institutions has been taking place almost yearly since 2001 and has continued until at least 2011. The collection of specimens, although often a contentious issue, does have scientific value but should be undertaken in a limited way with careful evaluation of the populations from which birds are being taken. We consider that the numbers collected are likely to pose a threat to some bird populations in view of their isolation and the slow turn-over rates of breeding individuals. Collecting has been carried out in some of the same reserves two or three times within a few years. Examples are given of very small populations in Malawi and adjacent Mozambique where the slightest off-take would be very dangerous. Many species have been collected during their breeding season, which we find both wasteful and unethical. Several of the species collected occur in no more than one or two reserves today in Malawi and in such instances we recommend their complete protection. We are also concerned about the example presented to the local communities, reserve wardens and young conservation biologists by the off-take of hundreds of birds in official reserves which were primarily set up for the protection of wildlife.

International reserves and growth: assessing the mercantilist motive in Latin America

Official reserves have increased to unprecedented levels since the mid-1990s, particularly in developing economies. One of the reasons ascribed for accumulating official reserves is the so-called mercantilist motive. This motive is seen as a part of an active industrial policy in the sense that these resources allow the monetary authorities to maintain a stable and undervalued real exchange rate, promoting economic growth and development via the tradable goods sector. In this paper we attempt to assess this motive using data for ten selected Latin American economies during the period 1996–2011. Unlike most previous work done on this topic, we consider official reserves as one of the determinants of the real exchange rate. Our econometric findings indicate that international reserves in the region appreciate the real exchange rate. This result suggests that the strategy of hoarding reserves in Latin America has not promoted economic growth and development.

The Gold Market and the Value of the U.S. Dollar

The aim of this research is to determine to what extent the price of gold is suppressed, thereby revealing an internal structural problem within the global monetary system. Historical manipulation could only have been done by controlling the value of money under a fractional reserve gold standard through the physical demand for, and supply of gold, in relation to official reserves held at a central bank. More recently, the price of gold is largely influenced through paper trades, as a function of the operation of the gold market involving gold derivatives, in conjunction with physical trades and changes in official reserves. This research adopts a qualitative interpretation and numerical analysis to analyze the extent of market concentration and price manipulation. Our findings reveal that the gold market is largely deterministic rather than stochastic in nature. It also reveals that markets are not only subject to a fractional reserve banking system, but also a fractional reserve gold market, highlighting systemic instability inherent within the modern monetary system, and especially the value of the U.S. dollar and related dollar denominated assets.

International Financial Flows in Low‐Income Countries

AbstractFor a sample of low‐income countries, we analyse the behaviour of international financial flows during three periods: (i) the 2003–2007 global boom; (ii) the 2008–2009 crisis; and (iii) the 2010–2012 recovery phase. In particular, we examine aid‐adjusted net financial inflows, debt inflows, foreign direct investment inflows and official reserve outflows. We highlight the role of country characteristics in explaining the cross‐country variation in international financial flows during these different phases.

Foreign Exchange Reserve Diversification and the 'Exorbitant Privilege'

We assess the global macroeconomic implications of different strategies of official reserve management by developing a large scale new-Keynesian dynamic general equilibrium model of the world economy, calibrated on the euro area, the United States, China, Japan and the rest of the world. An increase in global demand for euros would boost euro-area aggregate demand because of the reduction in euro-area interest rates (the main benefit associated with the “privilege” of being a global currency). If the higher demand for euros is associated with lower demand for US dollars, then US economic activity falls because of higher interest rates, which depress domestic aggregate demand, while the external balance improves; countries accumulating reserves continue to run a trade surplus, as exports to the euro-area increase. We also compute welfare gains/costs for all economies.

Macroeconomic and Fiscal Challenges Faced by the Southern and Eastern Mediterranean Region

The current fiscal imbalances and fragilities in the Southern and Eastern Mediterranean countries (SEMC) are the result of decades of instability, but have become more visible since 2008, when a combination of adverse economic and political shocks (the global and European financial crises, Arab Spring) hit the region. In an environment of slower growth and higher public expenditure pressures, fiscal deficits and public debts have increased rapidly. This has led to the deterioration of current accounts, a depletion of official reserves, the depreciation of some currencies and higher inflationary pressure. To avoid the danger of public debt and a balance-of-payment crisis, comprehensive economic reforms, including fiscal adjustment, are urgently needed. These reforms should involve eliminating energy and food subsidies and replacing them with targeted social assistance, reducing the oversized public administration and privatizing public sector enterprises, improving the business climate, increasing trade and investment openness, and sector diversification. The SEMC may also benefit from a peace dividend if the numerous internal and regional conflicts are resolved. However, the success of economic reforms will depend on the results of the political transition, i.e., the ability to build stable democratic regimes which can resist populist temptations and rally political support for more rational economic policies.

Habitat Suitability Modeling for the Newell's Shearwater on Kauai

Abstract The Newell's shearwater, or ‘A’o Puffinus newelli, is endemic to the main islands of the Hawaiian Archipelago and is listed as endangered on the International Union for Conservation of Nature Red List and as threatened under the U.S. Endangered Species Act. Using abiotic and biotic environmental variables, we developed a terrestrial habitat suitability model for this species on Kauai to predict habitat that could be suitable in the absence of anthropogenic threats. In addition, we developed a habitat/threat-isolation index incorporating information from our suitability model to identify regions of structurally suitable habitat with less exposure to certain anthropogenic threats (relative to other portions of the island). The habitat suitability model suggests that slope, density of rock fragments within the soil, and native vegetation cover are important factors associated with the current known distribution of the Newell's shearwater on Kauai, and that a moderate portion of the sloped interior terrain of Kauai could potentially be suitable nesting habitat for this species. The habitat/threat-isolation index identified the mountains on the north-central portion of the island as structurally suitable habitat most isolated from a combination of major anthropogenic disturbances (relative to other portions of the island). Much of this region, however, is privately owned and not designated as an official reserve, which could indicate a need for increased conservation action in this region in the future. This information is important for conservation biologists and private landowners because expanding efforts to control nonnative predators, as well as management of additional lands as reserves, may be necessary for the protection and preservation of the Newell's shearwater.

The role of the Federal Reserve as an international lender of last resort during the 2007–2008 financial crisis

During the 2007–2008 financial crisis several banking systems suffered shortages in U.S. dollars. The liquidity crisis of these banking systems was overcome thanks to the successful intervention of the Federal Reserve that granted swap lines to several central banks, acting as an international lender of last resort. In this paper we show that the Fed’s intervention was motivated principally by its desire to safeguard the stability of the U.S. banking system. For this reason the Fed’s action was expected by the countries whose banking systems had met with a U.S. dollars shortage. In taking for granted the support of the Fed, the authorities of these countries were affected by forms of ex-ante moral hazard, such as the holding of low amounts of official reserves.

South Sudan Secession: Modelling the Fiscal Shock and Its Spillover Effects

In this article we set up a macroeconomic model designed to describe how a small and open economy endures political uncertainty arising from a country splitting into two independent parts. According to our findings in this paper, stabilization of asset markets in either country at the post-secession era depends on political stability, which will impact on foreign currency inflows to each country. Our model predicts that if political unrest continues after the split, the foreign currency reserves of each other country’s Central Bank will deteriorate over time, possibly leading to domestic depreciation of the local currency in terms of hard currencies. The model also predicts that an expanding budget deficit and declining official reserves will eventually force governments to abandon fixed exchange rate systems in favor of more flexible ones, resulting in further acceleration of both the domestic inflation rate and the domestic money growth rate. As a result, the post-secession period is likely to be characterized by economic instability and political unrest in the two sides unless economic cooperation between the two countries is maintained.

Currency Wars

Currency Wars

Pakistan: Staff Report for the First Review Under the Extended Arrangement Under the Extended Fund Facility, Request for Waiver of Nonobservance of a Performance Criterion and Modification of Performance Criteria

This paper provides an update on economic and policy developments in Pakistan since the issuance of the IMF staff report on December 11, 2013. Gross official reserves were US$3.4 billion as of December 16, 2013, in line with IMF staff projections. The State Bank of Pakistan purchased an additional US$75 million on top of the US$200 reported in the staff report in the foreign exchange spot market as part of the continued effort to build reserves. The exchange rate rebounded slightly and was down some 8 percent against the dollar since the end of June. Headline inflation reached 10.9 percent year over year in November from 9.1 percent in October. This is in line with IMF staff projections and mainly reflects food price increases.