Demand for International Reserves Ji Kim

Demand for International Reserves The bank’s assets Domestic government bonds International reserves Role of International Reserves Can be traded to foreigners for goods Help on financial crises When the value of domestic assets decrease

Basic Model Assumptions 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 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 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 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 Caused by rapid globalization of financial markets in recent years