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

  • Fernando Aportela
  • Francisco Gallego
  • Pablo García

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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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. Roberto Chang & Andrés Velasco, 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Documentos de Trabajo 59, Centro de Economía Aplicada, Universidad de Chile.
  2. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  3. Rodrigo Fuentes & Alejandro Jara & Klaus Schmidt-Hebbel & Matías Tapia & Erika Arraño, 2003. "Efectos de la Nominalización de la Política Monetaria en Chile," Working Papers Central Bank of Chile 197, Central Bank of Chile.
  4. Martin Feldstein, 1999. "Self-Protection for Emerging Market Economies," NBER Working Papers 6907, National Bureau of Economic Research, Inc.
  5. 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.
  6. Amartya Lahiri & Carlos A. Vegh, 2001. "Living with the Fear of Floating: An Optimal Policy Perspective," NBER Working Papers 8391, National Bureau of Economic Research, Inc.
  7. Kraay, Aart & Loayza, Norman & Servén, Luis & Ventura, Jaume, 2001. "Country Portfolios," CEPR Discussion Papers 2974, C.E.P.R. Discussion Papers.
  8. Manuel R. Agosin & Ernesto Pastén H., 2003. "Corporate Governance in Chile," Working Papers Central Bank of Chile 209, Central Bank of Chile.
  9. 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.
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