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Demand for
International Reserves
Ji Kim
Demand for International Reserves

The bank’s assets
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Domestic government bonds
International reserves
Role of International Reserves
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
Can be traded to foreigners for goods
Help on financial crises

When the value of domestic assets decrease
Basic Model Assumptions
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Domestic and foreign bonds are perfect
substitute
Exchange rate is fixed
Absolute confidence in the fixed EXRA

Individual central banks can acquire all the
international reserves they need

Monetary policy is ineffective
Gold Standard

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Gold has been treated as international
asset
Debate whether the U.S.D. can play role
as international asset today
Euro is the strongest challenger to the
dollar
Benefit of Holding International
Reserves

International reserves utilized to cover a
sudden drop in export earnings
Influences to Demand on
International Reserves

The variability levels of exports, imports,
and international financial flow

Thus, higher economic openness leads to
lower demand for international reserves

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Openness makes adjustments easier
On the other hand, higher openness might
cause an economy to become more
vulnerable which will increase the demand

Foreign trade shock
Cost of Holding International
Reserves

Loss of interest on the domestic bonds

Earns the interest on dollars instead

International reserves may offer lower interest
rate due to their higher liquidity
Flexible Exchange Rates and
Demand for International Reserves

In 1960s, theoretically countries with
more flexible exchange rate could
generate export surplus with low
running international reserves

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Theoretically, they could depreciate their
currencies to avoid recession
In early 1970s, the industrial countries
moved to floating exchange rate

Economists expected that demand for the
reserves would drop substantially

However, industrial-country reserves
have grown as the same pace as the
nominal industrial-country income

1982-1992, the sharp decline in
developing-country reserve is
influenced by an international debt
crisis during the years 1982-989

Developing country with flexible EXRA
might need to pay off foreign creditors
and domestic residents with dollar to
avoid a financial crisis and currency
collapse
The Variability and Demand for
International Reserves

The variability in the balance of payment
still influence the demand for
international reserves.

Today's, huge increase in potential
variability and in the potential risks of
variability
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Caused by rapid globalization of financial
markets in recent years