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The role of international reserves holding in buffering external shocks

Jean-Pierre Allegret () and Audrey Allegret

Applied Economics, 2018, vol. 50, issue 29, 3128-3147

Abstract: An extended literature analyses the accumulation foreign exchange holding observed in many developing and emerging countries since the 2000s. Empirical studies on the self-insurance motive suggest that high-reserves economies are more resilient to financial crises and to international capital inflows volatility. They show also that pre-crisis foreign reserve accumulation explains post-crisis growth. However, some papers suggest that the relationship between international reserves holding and reduced vulnerability is nonlinear, meaning that reserve holding is subject to diminishing returns. This article devotes more attention to the potential nonlinear relationship between the foreign reserves holding and macroeconomic resilience to shocks. For a sample of nine emerging economies, we assess to what extent the accumulation of international reserves allows to mitigate negative impacts of external shocks on the output gap. While a major part of the literature focuses on the global financial crisis, we investigate this question by considering two sub-periods: 1995–2003 and 2004–2013. We implement threshold VAR model in which the structure is allow to change if the threshold variable crosses a certain estimated threshold. We find that the effectiveness of reserve holding to improve the resilience of domestic economies to shocks has increased over time. Hence, the diminishing returns of foreign reserve holding stressed in the previous literature must be qualified.

Date: 2018
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Related works:
Working Paper: The Role of International Reserves Holding in Buffering External Shocks (2018) Downloads
Working Paper: The role of international reserves holding in buffering external shocks (2016)
Working Paper: The Role of International Reserves Holding in Buffering External Shocks (2015) Downloads
Working Paper: The role of international reserves holding in buffering external shocks (2015)
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