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International reserves for emerging economies: A liquidity approach

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  • Jung, Kuk Mo
  • Pyun, Ju Hyun

Abstract

The massive stocks of foreign exchange reserves, mostly held in the form of U.S. T-bonds by emerging economies, are still an important puzzle. Why do emerging economies continue to willingly loan to the United States despite the low rates of return? We suggest that a dynamic general equilibrium model incorporating international capital markets, characterized by decentralized trade and U.S. T-bonds as facilitators of trade, can provide one possible resolution to this question. Declining financial frictions in these over-the-counter (OTC) markets would generate rising liquidity premium on U.S. T-bonds, thereby causing low U.S. real interest rates. Meanwhile, the superior liquidity properties of the U.S. T-bonds would induce recipients of foreign investments, namely emerging economies, to hold more liquidity, that is U.S. T-bonds, in equilibrium. The prediction of our model is confirmed by an empirical simultaneous equations approach considering an endogenous relationship between OTC capital inflows and reserve holdings.

Suggested Citation

  • Jung, Kuk Mo & Pyun, Ju Hyun, 2016. "International reserves for emerging economies: A liquidity approach," Journal of International Money and Finance, Elsevier, vol. 68(C), pages 230-257.
  • Handle: RePEc:eee:jimfin:v:68:y:2016:i:c:p:230-257
    DOI: 10.1016/j.jimonfin.2016.06.020
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    Cited by:

    1. Athanasios Geromichalos & Kuk Mo Jung, 2014. "An Over-the-Counter Approach to the FOREX Market," Working Papers 144, University of California, Davis, Department of Economics.
    2. Liu, Tao & Lu, Dong & Zhang, Ruifeng, 2017. "Currency choice in international trade: a new monetarist approach and firm-level evidence," MPRA Paper 79149, University Library of Munich, Germany.

    More about this item

    Keywords

    International reserves; Over-the-counter markets; Liquidity; Simultaneous equations;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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