International Reserves: Precautionary vs. Mercantilist Views, Theory, and Evidence

Jaewoo Lee () and Joshua Aizenman ()

No 05/198, IMF Working Papers from International Monetary Fund

Abstract: This paper compares the importance of precautionary and mercantilist motives in the hoarding of international reserves by developing countries. Overall, empirical results support precautionary motives; in particular, a more liberal capital account regime increases international reserves. Theoretically, large precautionary demand for international reserves arises as a self-insurance to avoid costly liquidation of long-term projects when the economy is susceptible to sudden stops. The welfare gain from the optimal management of international reserves is of a first-order magnitude, reducing the welfare cost of liquidity shocks from a first-order to a second-order magnitude.

Keywords: Foreign exchange reserves; Financial crisis; Demand; Capital account; Economic models (search for similar items in EconPapers)
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Date: 2005-10-27
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