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The Optimal Level of International Reserves for Emerging Market Countries

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Author Info

  • Romain Ranciere
  • Olivier Jeanne

Abstract

We present a model of the optimal level of international reserves for a small open economy that is vulnerable to sudden stops in capital flows. Reserves allow the country to smooth domestic absorption in response to sudden stops, but yield a lower return than the interest rate on the country''s long-term debt. We derive a formula for the optimal level of reserves, and show that plausible calibrations can explain reserves of the order of magnitude observed in many emerging market countries. However, the recent buildup of reserves in Asia seems in excess of what would be implied by an insurance motive against sudden stops.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/229.

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Length: 33
Date of creation: 01 Oct 2006
Date of revision:
Handle: RePEc:imf:imfwpa:06/229

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Related research

Keywords: Foreign exchange reserves; Capital flows; Emerging markets; Economic models; probability; domestic absorption; calibration; short-term debt; external debt; equation; equations; statistics; current account; financial statistics; sensitivity analysis; balance of payments; public debt; private external debt; long-term debt; optimization; external liabilities; computations; calibrations; standard deviation; regression analysis; external borrowing; reserve accumulation; sample mean; liquid reserves; debt crisis; short term debt; foreign debt; central bank; current account adjustment; predictions; market debt; reserve management; parameter change; current account balance; prediction; stock of debt; empirical estimation; current account surpluses; debt service; currency crises;

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References

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  1. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2004. "The revived Bretton Woods system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(4), pages 307-313.
  2. Joshua Aizenman & Jaewoo Lee, 2005. "International Reserves," IMF Working Papers 05/198, International Monetary Fund.
  3. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June.
  4. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  5. Ricardo J. Caballero & Stavros Panageas, 2004. "Contingent Reserves Management: An Applied Framework," NBER Working Papers 10786, National Bureau of Economic Research, Inc.
  6. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals, and Sudden Stops," IMF Staff Papers, Palgrave Macmillan, vol. 51(s1), pages 1-49, June.
  7. Romain Ranciere & Aaron Tornell & Frank Westermann, 2004. "Crises and Growth: A Re-evaluation," UCLA Economics Working Papers 832, UCLA Department of Economics.
  8. Fernando Broner & Guido Lorenzoni & Sergio L. Schmukler, 2003. "Why do emerging economies borrow short term?," Economics Working Papers 838, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2011.
  9. Pablo García & Claudio Soto, 2004. "Large Hoardings of International Reserves: Are They Worth It?," Working Papers Central Bank of Chile 299, Central Bank of Chile.
  10. Robert P. Flood & Nancy P. Marion, 2002. "Holding International Reserves in an Era of High Capital Mobility," IMF Working Papers 02/62, International Monetary Fund.
  11. Joshua Aizenman & Nancy Marion, 2002. "The high demand for international reserves in the Far East: what's going on?," Pacific Basin Working Paper Series 2002-08, Federal Reserve Bank of San Francisco.
  12. Sebastian Edwards, 2004. "Thirty Years of Current Account Imbalances, Current Account Reversals and Sudden Stops," NBER Working Papers 10276, National Bureau of Economic Research, Inc.
  13. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-97, June.
  14. repec:rus:hseeco:181565 is not listed on IDEAS
  15. Pablo E. Guidotti & Federico Sturzenegger & Agustín Villar, 2004. "On the Consequences of Sudden Stops," JOURNAL OF LACEA ECONOMIA, LACEA - LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION.
  16. David Hauner, 2006. "A Fiscal Price Tag for International Reserves," International Finance, Wiley Blackwell, vol. 9(2), pages 169-195, 08.
  17. Christian B. Mulder & Matthieu Bussière, 1999. "External Vulnerability in Emerging Market Economies," IMF Working Papers 99/88, International Monetary Fund.
  18. repec:bge:wpaper:185 is not listed on IDEAS
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