IMF Working Papers

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

Author/Editor:

Joshua Aizenman ; Jaewoo Lee

Publication Date:

October 1, 2005

Summary:

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.

Series:

Working Paper No. 2005/198

Subject:

Capital account liberalization Export performance International reserves Liquidity Reserves accumulation