The currency composition of international reserves, demand for international reserves, and global safe assets

This paper examines determinants of the international reserves (IR) currency composition before and after the Global Financial Crisis (GFC). Applying the annual data of 58 countries, we confirm that countries that trade more with the US, euro zone, UK, and Japan, and issue more debt denominated in the big four currencies (US dollar, euro, pound, and yen) hoard more IR in these currencies. We find scale effects in which countries tend to diversify from the big four currencies as they increase their IR/GDP and that a growing shortage of global safe assets (GSAs) induces countries to hold more big four currencies. Countries hold less big four currencies as IR after the 2008 GFC, while they hold more of such currencies since the tapering of the Fed’s quantitative easing (QE). The 2008 GFC and QE tapering weakened and sometimes reversed the effect of several economic factors. We also find that TARGET2 balances matter for the currency composition of IR in the euro zone; commodity-exporting countries tend to diversify their IR from the big four currencies when their terms of trade improve; and that the valuation effects induced by Euro/USD exchange rate changes diminish the significance of the GFC in explaining the currency composition of IR.