Too Much of a Good Thing? The Adequacy of International Reserves in the Aftermath of Crises

Abstract

This paper has a number of purposes. First, it revisits the older theory of reserve adequacy and optimality to see whether this can still be used and perhaps strengthened in ways that would inform the current debate. Second, it explores the connection between reserve adequacy and currency crisis in the light of recent experience and empirical research. Third, it critically investigates alternative rule-of-thumb measures of reserve adequacy. Fourth, and drawing on the foregoing analysis, it examines the extent to which crisis countries should seek to replenish and build up their international reserves in the post-crisis period. Additional owned reserves represent a guaranteed and unconditional source of liquidity; is this what is needed?

What Makes Developing Asia Resilient in a Financially Globalized World?

“…While the high level of reserves revealed is crucial to cushion against external shocks over the past year, which was also highlighted in the empirical analysis in the previous section, carrying excessive reserves entails costs due to its poor management (Bird and Rajan 2003). In fact, most of developing Asia already meets the criterion suggested by conventional measures in terms of precautionary needs, such as the Guidotti-Greenspan rule (Feldstein 1999), which says that a country's liquid foreign exchange reserves should at all times cover its foreign currency debt repayable within 1 year (shown in the right-hand side of Figure 5.1), and that reserves can cover import bills for a number of months (shown in the left-hand side of Figure 5.1).…”

A Fiscal Price Tag for International Reserves

“…Heller (1966) assumes 5-10 percent; Frenkel and Jovanovic (1981), Flood and Marion (2002), and Edison (2003) assume that it equals some government bond yields. Edwards (1985), Landell-Mills (1989), and Bird and Rajan (2003) avoid the problem altogether by assuming that all opportunity cost comes from forgone debt repayment and ignoring potential other alternative uses of reserves; and Lee (2004) assumes that the opportunity cost equals the liquidity premium on the reserve asset.…”

International reserves for emerging economies: A liquidity approach

“…2 See, for example, Bird and Rajan (2003), Rodrik (2006), Aizenman and Lee (2008), Cheung and Qian (2009), and Obstfeld, Shambaugh, and Taylor (2010). 3 A recent empirical study by Krishnamurthy and Vissing-Jorgensen (2012) demonstrates that U.S. Treasury bonds have superb liquidity that is akin to the U.S. dollar.…”