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The buffer stock model redux? An analysis of the dynamics of foreign reserve accumulation

Emerging market economies have recently accumulated large stocks of foreign reserves. In this paper we address the question of what are the main factors accounting for reserve holdings in nine developing countries located in Asia and Latin America. Monthly data from January 1985 to May 2006 are used to estimate for each country the long run equilibrium reserve demand, based on the buffer stock model, the short run dynamics governing the process of reserve accumulation (decumulation) and the factors which may influence the speed of adjustment of actual to desired reserves. Cointegration analysis suggests that the buffer stock precautionary model accounts for the optimal reserve demand. The corresponding VECMs are further interpolated, using the permanent and transitory innovations decomposition procedure of Gonzalo and Ng (2001), in order to assess the relative impact of the time series on the convergence to equilibrium after a shock. Finally the (asymmetric) effect on the speed of convergence of positive/negative changes in signal variables - such as the excess reserves of the previous period, relative competitiveness and US monetary stance - is found to be significant, in line with mercantilistic and fear of floating motives for hoarding international reserves.

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Paper provided by Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa in its series Working Papers - Economics with number wp2007_02.rdf.

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Length: 40 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:frz:wpaper:wp2007_02.rdf
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