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Can High Reserves Offset Weak Fundamentals? A Simple Model of Precautionary Demand for Reserves

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Author Info

  • Jie Li

    ()
    (Claremont Graduate University, California.)

  • Ramkishen Rajan

    ()
    (School of Public Policy, National University of Singapore.)

Abstract

Apart from exchange rate objectives which have resulted in reserve accumulation as a side effect, Asian countries have chosen explicitly to build up reserves at least in part for precautionary motives. This paper explores the issue of optimal precautionary demand for reserves by a central bank within a context of a simple analytical model. The model suggests that, in general, high reserves can help offset moderately weak fundamentals. However, if fundamentals are sufficiently weak, no level of reserves will be able to counterbalance the weak fundamentals. This is broadly consistent with the escape clause based second-generation models of currency crisis.

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File URL: http://www.adelaide.edu.au/cies/papers/0509.pdf
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Bibliographic Info

Paper provided by University of Adelaide, Centre for International Economic Studies in its series Centre for International Economic Studies Working Papers with number 2005-09.

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Length: 21 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:adl:cieswp:2005-09

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Keywords: crisis management; crisis prevention; currency crisis; precautionary motive; reserves.;

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References

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  1. Ben-Bassat, Avraham & Gottlieb, Daniel, 1992. "Optimal international reserves and sovereign risk," Journal of International Economics, Elsevier, vol. 33(3-4), pages 345-362, November.
  2. Keltzer, K. & Spiegel, M., 1999. "Sterilization Costs and Exchange Rate Targeting," Papers pb99-03, Economisch Institut voor het Midden en Kleinbedrijf-.
  3. Christian B. Mulder & Matthieu Bussière, 1999. "External Vulnerability in Emerging Market Economies," IMF Working Papers 99/88, International Monetary Fund.
  4. M. Nowak & Ketil Hviding & Luca Antonio Ricci, 2004. "Can Higher Reserves Help Reduce Exchange Rate Volatility?," IMF Working Papers 04/189, International Monetary Fund.
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Cited by:
  1. Xingwang Qian & Andreas Steiner, 2012. "International Reserves and the Composition of Equity Capital Inflows," Working Papers 90, Institute of Empirical Economic Research.
  2. Martín Redrado & Jorge Carrera & Diego Bastourre & Javier Ibarlucia (ed.), 2006. "The Economic Policy of Foreign Reserve Accumulation: New International Evidence," BCRA Paper Series, Central Bank of Argentina, Economic Research Department, number 02, June.
  3. Cavoli, Tony & Rajan, Ramkishen S., 2009. "Managing Risks in a Volatile Environment: The Capital Inflows Problem in Asia," Economia Internazionale / International Economics, Camera di Commercio di Genova, vol. 62(3), pages 325-340.
  4. Mendoza, Ronald U., 2010. "Was the Asian crisis a wake-up call?: Foreign reserves as self-protection," Journal of Asian Economics, Elsevier, vol. 21(1), pages 1-19, February.
  5. Jie Li & Alice Ouyang, 2011. "Currency crises: can high reserves offset vulnerable fundamentals?," Applied Economics, Taylor & Francis Journals, vol. 43(16), pages 2055-2069.
  6. Martín Redrado & Jorge Carrera & Diego Bastourre & Javier Ibarlucia, 2006. "The Economic Policy of Foreign Reserve Accumulation: New International Evidence," BCRA Working Paper Series 200614, Central Bank of Argentina, Economic Research Department.

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