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Reserves Over the Transitions to Floating and to Inflation Targeting: Lessons From the Developed World

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  • Fernando Aportela
  • Francisco Gallego
  • Pablo García

Abstract

This paper highlights the evolution of official international reserves in developed countries that transited towards Inflation Targeting (IT) and/or floating exchange rates. We find several results that are of interest to policymakers in emerging countries, such as Brazil, Chile and Mexico, which have revamped their monetary and exchange rate arrangements along those lines. First, the adoption of a floating exchange rate and an IT framework are associated with a persistent 10% to 20% reduction in real official reserves held at the Central Bank. Second, this reduction in official reserves corresponds mainly to a reallocation of international liquidity towards the private financial sector, that accommodates part of the effect on the level or composition of the net foreign asset position of the countries. Third, there is a clear change in the correlation between interest rate differentials and the dynamics of official reserves, strongly supporting the Mundell-Fleming result regarding the exogeneity of money supply under floating exchange rates. Fourth, the latter also shows that, once constraints on exchange rate volatility are removed, the stock of reserves can be determined independently by the Central Bank, according to cost-benefit analysis, without hindering the credibility of the combination of a floating regime and inflation targeting.

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Bibliographic Info

Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 211.

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Date of creation: May 2003
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Handle: RePEc:chb:bcchwp:211

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  1. Kraay, Aart & Loayza, Norman & Serven, Luis & Ventura, Jaume, 2004. "Country Portfolios," Policy Research Working Paper Series 3320, The World Bank.
  2. Ricardo J. Caballero & Arvind Krishnamurthy, 2000. "International Liquidity Management: Sterilization Policy in Illiquid Financial Markets," Econometric Society World Congress 2000 Contributed Papers 1700, Econometric Society.
  3. Amartya Lahiri & Carlos A. Végh, 2002. "Living with the Fear of Floating: An Optimal Policy Perspective," NBER Chapters, in: Preventing Currency Crises in Emerging Markets, pages 663-704 National Bureau of Economic Research, Inc.
  4. Ricardo J. Caballero, 2000. "Macroeconomic Volatility in Latin America: A Conceptual Framework and Three Case Studies," Journal of LACEA Economia, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  5. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  6. Martin Feldstein, 1999. "Self-Protection for Emerging Market Economies," NBER Working Papers 6907, National Bureau of Economic Research, Inc.
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Cited by:
  1. Claudio Soto G. & Alberto Naudon D. & Eduardo López E. & Álvaro Aguirre R., 2004. "About International Reserve Adequacy: The Case of Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 7(3), pages 5-34, December.

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