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

Author/Editor:

Romain Ranciere ; Olivier D Jeanne

Publication Date:

October 1, 2006

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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.

Series:

Working Paper No. 2006/229

Subject:

Balance of payments Central banks Consumption Emerging and frontier financial markets Exchange rate arrangements External debt Financial markets Reserve positions Reserves accumulation Sudden stops

English

Publication Date:

October 1, 2006

ISBN/ISSN:

9781451864892/1018-5941

Stock No:

WPIEA2006229

Pages:

33

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