The Optimal Level of International Reserves for Emerging Market Countries: Formulas and Applications

Romain Ranciere and Olivier Jeanne

No 2006/229, IMF Working Papers from International Monetary Fund

Abstract: We present a model of the optimal level of international reserves for a small open economy that is vulnerable to sudden stops in capital flows. Reserves allow the country to smooth domestic absorption in response to sudden stops, but yield a lower return than the interest rate on the country's long-term debt. We derive a formula for the optimal level of reserves, and show that plausible calibrations can explain reserves of the order of magnitude observed in many emerging market countries. However, the recent buildup of reserves in Asia seems in excess of what would be implied by an insurance motive against sudden stops.

Keywords: WP; short-term debt; exchange rate; private sector; Foreign Exchange Reserves; Balance of Payments Crises; Sudden Stops; Capital Flows; level of reserve; open economy; reserve adequacy literature; rollover crisis; long-term debt; probability of a sudden stop; regime dummy; Reserve positions; Reserves accumulation; Emerging and frontier financial markets; Asia and Pacific; Global (search for similar items in EconPapers)
Pages: 33
Date: 2006-10-01
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Citations: View citations in EconPapers (182)

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