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The non-linear impact of monetary policy on international reserves: macroeconomic variables nexus

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Abstract

This paper employs panel smooth transition regression models to investigate the nonlinear effects of two monetary policy proxies (i.e., real exchange rate return and real interest rate differential) on the international reserves—macroeconomic variables nexus. The panel data set includes the fourteen G-20 countries during the period 1991–2012. Empirical results show that the marginal effects of the macroeconomic variables (savings, terms of trade, public debt, capital account liberalization, economic growth, and trade openness) on international reserves are non-linear and vary with time, the proxies and countries, not linear and constant derived from traditional linear model. Currency devaluation policy (against the US dollar) can non-linearly enlarge the positive contribution of trade openness and public debt on international reserves, and non-linearly reduce the negative impact of terms of trade on international reserves, as the Marshall–Lerner condition holds. Expansionary monetary policy (through the decrease in domestic interest rates) can strengthen the positive effects of public debt, trade openness, and economic growth on international reserves. The precautionary and mercantilist views of reserves holdings are partially supported.

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Notes

  1. Even for developed countries, the hoarding of international reserves is required to resist financial turmoil such as the European debt crisis in 2008 and the subprime crisis in 2006.

  2. See the World Development Index of World Bank in 2012.

  3. van Dijk et al. (2002) indicate that lagged depend variable or other exogenous variables can be used as the transition variable.

  4. For more details on the testing of no remaining non-linearity, see Colletaz and Hurlin (2006).

  5. Considering the data available, we exclude six countries and regions: Argentina, Brazil, Russia, Saudi Arabia, the European Union, and Turkey.

  6. Levin et al. (2002) indicate that LLC test performs well as the number of cross-sectional objects (N) and the number of time series (T) both range between 5 and 250. In this study, N = 14 and T = 22; therefore, LLC test is an appropriate method to evaluate the stationarity of the variables of concern.

  7. Engle and Granger (1987) show that if the linear combination of a set of non-stationary variables is stationary, then these variables have co-integration relationships. That is, they have long-term equilibrium relationships.

  8. ARDL model has the following advantages: (1) it does not need to consider the integrated order of the variables in the process of testing; (2) it can improve low power problem as the sample size is small; (3) it can distinguish whether variables are dependent or independent ones, and (4) it can evaluate the short-term or long-term relationship among variables by adding lagged error correction factors in the model (Naiya and Manap 2013). For more details about the ARDL model, see Bildirici and Kayıkçı (2013).

  9. Krugman and Taylor (1978) indicate that a currency devaluation policy does not necessarily stimulate aggregate demand as the expenditure-switching effect is smaller than the expenditure-reducing effect.

  10. Several empirical studies support negative effects of economic growth on capital inflows. For example, Wint and Williams (2002), Jensen (2003), and Buchanan et al. (2012) all find a significantly negative impact of economic growth in attracting capital inflows in developing countries. One probable reason for such empirical results is that it is a measurement artifact. That is, economies that grow at a faster rate than the growth in capital inflows will experience a decrease in capital inflows as a percentage of GDP. In addition, while a number of industrialized countries were in recession during the early 1980 s, they experienced increased FDI (Jensen, 2003). In such cases, low economic growth is associated with high FDI.

  11. The time-varying and country-specific transition variables have provided the explanation of the sensitivity analysis. The time- and country-varying marginal effects of the regressors on international reserves represent the influence of a minor change in real exchange rate return or real interest rate differential on the marginal effects.

  12. The robustness analysis can be confirmed by the two estimated PSTR models. In the two models, we choose real exchange rate return and real interest rate differential as the transition variables, and the optimal estimation model is the PSTR model with r = m = 1 and d = 0. Clearly, the replacement of transition variable does not change the optimal estimation model. That is, the estimation results are robust. In addition, the comparison between estimation results in linear and nonlinear models also supports the robustness of the PSTR models. In brief, this paper employs statistical methods to verify the rationality of using the PSTR models.

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Authors and Affiliations

  1. Department of International Business, Chung Yuan Christian University, No. 200, Chung Pei Rd., Chung Li, 320, Taiwan, ROC

    Po-Chin Wu

  2. College of Business, Chung Yuan Christian University, No. 200, Chung Pei Rd., Chung Li, 320, Taiwan, ROC

    Chung-Chih Lee

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  1. Po-Chin Wu
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  2. Chung-Chih Lee
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Correspondence to Po-Chin Wu.

Appendix

Appendix

See Table 6.

Table 6 Choice of optimal PSTR estimation model
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Wu, PC., Lee, CC. The non-linear impact of monetary policy on international reserves: macroeconomic variables nexus. Empirica 45, 165–185 (2018). https://doi.org/10.1007/s10663-016-9353-3

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