Advertisement

Open Economies Review

, Volume 18, Issue 2, pp 191–214 | Cite as

International Reserves: Precautionary Versus Mercantilist Views, Theory and Evidence

  • Joshua Aizenman
  • Jaewoo Lee
Research article

Abstract

This paper compares the importance of precautionary and mercantilist motives in the hoarding of international reserves by developing countries. Overall, empirical results support precautionary motives; in particular, a more liberal capital account regime increases international reserves. Theoretically, large precautionary demand for international reserves arises as a self-insurance to avoid costly liquidation of long-term projects when the economy is susceptible to sudden stops. The welfare gain from the optimal management of international reserves is of a first-order magnitude, reducing the welfare cost of liquidity shocks from a first-order to a second-order magnitude.

Keywords

International reserves Precautionary demand Mercantilist Financial crises 

JEL Classification

F15 F31 F43 

Notes

Acknowledgments

We thank Hali Edison for sharing the data, and Aleksandra Markovic for research assistance in the earlier phase of the project. We thank Michael Dooley, Ann Harrison, Linda Goldberg, Pierre-Olivier Gourinchas, Maury Obstfled, Brian Pinto, Ramkishen Rajan, Andy Rose, Partha Sen, George Tavlas, Tom Willett and participants in the SERC conference (Singapore 2005), Berkeley seminar, and the FRBSF conference for their useful comments. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or IMF policy.

References

  1. Aizenman J, Marion NP (2003) The high demand for international reserves in the far east: what’s going on? J Jpn Int Econ 17(3):370–400CrossRefGoogle Scholar
  2. Aizenman J, Marion NP (2004) International reserves holdings with sovereign risk and costly tax collection. Econ J 114:569–591CrossRefGoogle Scholar
  3. Aizenman J, Lee Y, Rhee Y (2004) International reserves management and capital mobility in a volatile world: policy considerations and a case study of Korea. J Jpn Int EconGoogle Scholar
  4. Ben-Bassat A, Gottlieb D (1992) Optimal international reserves and sovereign risk. J Int Econ 33:345–362CrossRefGoogle Scholar
  5. Bryant R (1980) A model of reserves, bank runs, and deposit insurance. J Bank Financ 4:335–344CrossRefGoogle Scholar
  6. Calvo G (1998) Capital flows and capital-market crises: the simple economics of sudden stops. J Appl Econ 1(1):35–54Google Scholar
  7. Calvo G, Mendoza E (2000) Contagion, globalization, and the volatility of capital flows. In: Edwards S (ed) Capital flows and the emerging economies. University Chicago Press, ChicagoGoogle Scholar
  8. Diamond D, Dybvig P (1983) Bank runs, liquidity and deposit insurance. J Polit Econ 91:401–419CrossRefGoogle Scholar
  9. Dooley M, Folkerts-Landau D, Garber P (2003) An essay on the revived Bretton Woods System. NBER Working paper No. 9971Google Scholar
  10. Edison H (2003) Are foreign exchange reserves in Asia too high? IMF World Economic Outlook SeptemberGoogle Scholar
  11. Edwards S (1983) The demand for international reserves and exchange rate adjustments: the case of LDCs, 1964–1972. Economica 50:269–280CrossRefGoogle Scholar
  12. Edwards S (2004) Thirty years of current account imbalances, current account reversals, and sudden stops. IMF Staff Papers, vol 51, Special IssueGoogle Scholar
  13. Edwards S (2005) Capital controls, sudden stops and current account reversals. NBER Working Paper No. 11170Google Scholar
  14. Flood R, Marion NP (2001) Holding international reserves in an era of high capital mobility. In: Collins SM, Rodrik D (eds) Brookings trade forum 2001. Brookings Institution Press, Washington, DCGoogle Scholar
  15. Frankel J (2006) On the Yuan: the choice between adjustment under a fixed exchange rate and adjustment under a flexible rate. In: Illing G (ed) Understanding the Chinese economy. CESifo Economic Studies, MunichGoogle Scholar
  16. Frenkel J (1983) International liquidity and monetary control. In: von Furstenberg GM (ed) International Money and Credit: The Policy Roles. Washington: International Monetary FundGoogle Scholar
  17. García PS, Soto CG (2004) Large hoarding of international reserves: are they worth it? manuscript, Chilean Central BankGoogle Scholar
  18. Holmstrom B, Tirole J (1998) Private and public supply of liquidity. J Polit Econ 106:1–40CrossRefGoogle Scholar
  19. Hutchison M, Noy I (2005) How bad are twins? Output costs of currency and banking crises. J Money Credit Bank 37(4):725–752CrossRefGoogle Scholar
  20. Jeanne O, Ranciere R (2006) The optimal level of international reserves for emerging market economies: formulas and applications. IMF MimeoGoogle Scholar
  21. Kaminsky G, Reinhart C (1999) The twin crises. the causes of banking and balance-of-payments problems. Am Econ Rev 89:473–500CrossRefGoogle Scholar
  22. King M (2006) Reform of the international monetary fund. Speech: http://www.bankofengland.co.uk/publications/speeches/2006/speech267.pdf
  23. Kravis IB (1984) Comparative studies of national incomes and prices. J Econ Lit 22:1–39Google Scholar
  24. Lee J (2004) Insurance value of international reserves. IMF Working Paper No. 04/175Google Scholar
  25. Prisman E, Solvin M, Sushka M (1986) A general model of the banking firm under conditions of monopoly, uncertainty and recourse. J Monet Econ 17(2):293–304CrossRefGoogle Scholar
  26. Reinhart C, Rogoff K (2004) The modern history of exchange rate arrangements: a reinterpretation. Q J Econ 119(1):1–48CrossRefGoogle Scholar
  27. Rodrik D (2006) The social cost of foreign exchange reserves. NBER Working Paper No. 11952Google Scholar
  28. Samuelson PA (1994) Facets of Balassa-Samuelson thirty years later. Rev Int Econ 2(3):201–226CrossRefGoogle Scholar
  29. Skidelsky R (2000) John Maynard Keynes: Fighting for freedom, 1937–1946. Penguin Putnam, New YorkGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  1. 1.Economics Department and the NBERUniversity of CaliforniaSanta CruzUSA
  2. 2.Research DepartmentInternational Monetary FundWashingtonUSA

Personalised recommendations