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About International Reserve Adequacy: The Case of Chile

  • Claudio Soto G.
  • Alberto Naudon D.
  • Eduardo López E.
  • Álvaro Aguirre R.

Under a flexible exchange rate regime, international reserves contribute to reducing the risk of a financial crisis, and allow the monetary authority to intervene exceptionally in the exchange market. However, holding reserves is costly. In this paper, we analyze several issues concerning the adequate level of Chilean international reserves. First we compare the level of Chile's international reserves with those of different sets of countries, using various indicators. We then analyze empirically some of the benefits and costs of holding reserves. Our results show that Chile's international reserves are high when measured with respect to GDP or M2, but they are in line with those of countries of similar characteristics when measured as a fraction of short-term residual debt. On the other hand, given the low risk of the Chilean economy, marginal changes in reserves have a very low impact on both the probability of a financial crisis and the sovereign spread of the country. Finally, as the sovereign spread has decreased over the last years, so too has the cost of reserves. In fact, over the past few years Chile's cost of reserves as a fraction of GDP has been considerably lower than the cost of other emerging economies.

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File URL: http://www.bcentral.cl/estudios/revista-economia/2004/dic/Vol7N3dic2004pp5_34.pdf
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Article provided by Central Bank of Chile in its journal Economía Chilena.

Volume (Year): 7 (2004)
Issue (Month): 3 (December)
Pages: 5-34

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Handle: RePEc:chb:bcchec:v:7:y:2004:i:3:p:5-34
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  1. Aizenman, Joshua & Marion, Nancy P., 2003. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," Santa Cruz Department of Economics, Working Paper Series qt9s7978n1, Department of Economics, UC Santa Cruz.
  2. Fernandez-Arias, Eduardo & DEC, 1994. "The new wave of private capital inflows : push or pull?," Policy Research Working Paper Series 1312, The World Bank.
  3. Flood, Robert P. & Marion, Nancy P., 2004. "A model of the joint distribution of banking and currency crises," Journal of International Money and Finance, Elsevier, vol. 23(6), pages 841-865, October.
  4. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
  5. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America; The Role of External Factors," IMF Working Papers 92/62, International Monetary Fund.
  6. Jeanne, Olivier & Wyplosz, Charles, 2001. "The International Lender of Last Resort: How Large is Large Enough?," CEPR Discussion Papers 2842, C.E.P.R. Discussion Papers.
  7. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February.
  8. W. R. M. Perraudin & Manmohan S. Kumar & Uma Moorthy, 2002. "Predicting Emerging Market Currency Crashes," IMF Working Papers 02/7, International Monetary Fund.
  9. Aizenman, Joshua & Marion, Nancy, 2002. "Reserve Uncertainty and the Supply of International Credit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 631-49, August.
  10. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June.
  11. Ilan Goldfajn & Rodrigo Valdés, 1997. "Balance of Payments Crises and Capital Flows: The Role of Liquidity," Working Papers Central Bank of Chile 11, Central Bank of Chile.
  12. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  13. Martin Feldstein, 1999. "Self-Protection for Emerging Market Economies," NBER Working Papers 6907, National Bureau of Economic Research, Inc.
  14. Guillermo A. Calvo, 1996. "Capital flows and macroeconomic management: tequila lessons," Working Papers in Applied Economic Theory 96-02, Federal Reserve Bank of San Francisco.
  15. Gian-Maria Milesi-Ferretti & Assaf Razin, 1998. "Current Account Reversals and Currency Crisis; Empirical Regularities," IMF Working Papers 98/89, International Monetary Fund.
  16. Catherine A. Pattillo & Andrew Berg, 1998. "Are Currency Crises Predictable? a Test," IMF Working Papers 98/154, International Monetary Fund.
  17. Sebastian Edwards, 1984. "The Demand for International Reserves and Monetary Equilibrium: Some Evidence From Developing Countries," NBER Working Papers 1307, National Bureau of Economic Research, Inc.
  18. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sérgio, 1999. "Hedging and Financial Fragility in Fixed Exchange Rate Regimes," CEPR Discussion Papers 2171, C.E.P.R. Discussion Papers.
  19. Fernando Aportela & Francisco Gallego & Pablo García, 2003. "Reserves Over the Transitions to Floating and to Inflation Targeting: Lessons From the Developed World," Working Papers Central Bank of Chile 211, Central Bank of Chile.
  20. Matías Tapia & Andrea Tokman, 2003. "Efectos de las Intervenciones en el Mercado Cambiario: El Caso de Chile," Working Papers Central Bank of Chile 206, Central Bank of Chile.
  21. Enrica Detragiache & Antonio Spilimbergo, 2001. "Crises and Liquidity; Evidence and Interpretation," IMF Working Papers 01/2, International Monetary Fund.
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