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Can Higher Reserves Help Reduce Exchange Rate Volatility?

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Author Info

  • M. Nowak
  • Ketil Hviding
  • Luca Antonio Ricci

Abstract

This paper studies the role of an increase in foreign exchange reserves in reducing currency volatility for emerging market countries. The study employs a panel of 28 countries over the period 1986-2002. Several control variables are introduced in the regressions to account for other factors affecting exchange rate volatility (monetary and external indicators as well as conventional macroeconomic fundamentals). The paper controls for the endogeneity induced by the role of the exchange rate regime, since the regime can affect both the level of reserves and exchange rate volatility. The results provide ample support for the proposition that holding adequate reserves reduces exchange rate volatility. The effect is strong and robust; moreover, it is nonlinear and appears to operate through a signaling effect.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/189.

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Length: 10
Date of creation: 01 Oct 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/189

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Related research

Keywords: Exchange rate variability; Reserves adequacy;

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References

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  1. Michael B. Devereux & Philip R. Lane, 2002. "Understanding Bilateral Exchange Rate Volatility," Trinity Economics Papers 200211, Trinity College Dublin, Department of Economics.
  2. Hasan, Shahriar & Wallace, Myles, 1996. "Real exchange rate volatility and exchange rate regimes: Evidence from long-term data," Economics Letters, Elsevier, vol. 52(1), pages 67-73, July.
  3. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  4. Ricardo Hausmann & Ugo Panizza & Ernesto H. Stein, 2000. "Why Do Countries Float the Way They Float?," Research Department Publications 4205, Inter-American Development Bank, Research Department.
  5. Roberto Rigobon, 2003. "Identification Through Heteroskedasticity," The Review of Economics and Statistics, MIT Press, vol. 85(4), pages 777-792, November.
  6. Leonardo Bartolini & Gordon M. Bodnar, 1996. "Are exchange rates excessively volatile? And what does "excessively volatile" mean, anyway?," Research Paper 9601, Federal Reserve Bank of New York.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  8. Caramazza, Francesco & Ricci, Luca & Salgado, Ranil, 2004. "International financial contagion in currency crises," Journal of International Money and Finance, Elsevier, vol. 23(1), pages 51-70, February.
  9. Andrew K. Rose, 1994. "Are exchange rates macroeconomic phenomena?," Economic Review, Federal Reserve Bank of San Francisco, pages 19-30.
  10. Reinhart, Carmen & Calvo, Guillermo, 2000. "When Capital Inflows Come to a Sudden Stop: Consequences and Policy Options," MPRA Paper 6982, University Library of Munich, Germany.
  11. Jaewoo Lee, 2004. "Insurance Value of International Reserves: An Option Pricing Approach," IMF Working Papers 04/175, International Monetary Fund.
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Citations

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Cited by:
  1. Aizenman, Joshua, 2007. "International reserves management and the current account," Santa Cruz Department of Economics, Working Paper Series qt22q271t2, Department of Economics, UC Santa Cruz.
  2. Faisal Ahmed & Rabah Arezki & Norbert Funke, 2007. "The composition of capital flows to South Africa," Journal of International Development, John Wiley & Sons, Ltd., vol. 19(2), pages 275-294.
  3. Vivek B. Arora, 2007. "Monetary Policy Transparency and Financial Market Forecasts in South Africa," IMF Working Papers 07/123, International Monetary Fund.
  4. Jesus Gonzalez-Garcia & John Cady, 2006. "The IMF's Reserves Template and Nominal Exchange Rate Volatility," IMF Working Papers 06/274, International Monetary Fund.
  5. 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.
  6. Gilda Fernandez & Cem Karacadag & Rupa Duttagupta, 2004. "From Fixed to Float: Operational Aspects of Moving Towards Exchange Rate Flexibility," IMF Working Papers 04/126, International Monetary Fund.
  7. Jie Li & Ramkishen Rajan, 2005. "Can High Reserves Offset Weak Fundamentals? A Simple Model of Precautionary Demand for Reserves," Centre for International Economic Studies Working Papers 2005-09, University of Adelaide, Centre for International Economic Studies.
  8. International Monetary Fund, 2004. "Once Again, is Openness Good for Growth?," IMF Working Papers 04/135, International Monetary Fund.
  9. Drummond, Paulo & Dhasmana, Anubha, 2008. "Foreign Reserve Adequacy in Sub-Saharan Africa," MPRA Paper 9729, University Library of Munich, Germany.
  10. Martín Gonzalez-Eiras, 2009. "Quotas and Voting Shares in the IMF: Theory and Evidence," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(55), pages 57-91, July - Se.
  11. Ghiath Shabsigh & Nadeem Ilahi, 2007. "Looking Beyond the Fiscal: Do Oil Funds Bring Macreconomic Stability?," IMF Working Papers 07/96, International Monetary Fund.
  12. Mendoza Lugo, Omar & Pedauga, Luis Enrique, 2006. "Efecto transferencia (pass-through) del tipo de cambio en los precios de bienes y servicios en Venezuela
    [Exchange rate pass-through on prices of goods and services in Venezuela]    ," MPRA Paper 14874, University Library of Munich, Germany.
  13. Ganguly, Srideep & Breuer, Janice Boucher, 2010. "Nominal exchange rate volatility, relative price volatility, and the real exchange rate," Journal of International Money and Finance, Elsevier, vol. 29(5), pages 840-856, September.
  14. Daniel Stavárek, 2006. "Assessment Of The Exchange Rate Volatility In New Eu Member States And Romania1," Revista Tinerilor Economisti (The Young Economists Journal), University of Craiova, Faculty of Economics and Business Administration, vol. 1(6), pages 20-29, April.

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