The Optimal Level of Foreign Reserves in Financially Dollarized Economies: The Case of Uruguay

 
Author/Editor: Gonçalves, Fernando M.
 
Publication Date: November 01, 2007
 
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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: This paper extends the framework derived by Jeanne and Rancière (2006) by explicitly incorporating the dollarization of bank deposits into the analysis of the optimal level of foreign reserves for prudential purposes. In the extended model, a sudden stop in capital flows occurs in tandem with a run on dollar deposits. Reserves can smooth consumption in a crisis but are costly to carry. The resulting expression for the optimal level of reserves is calibrated for Uruguay, a country with high dollarization of bank deposits. The baseline calibration indicates that the gap between actual and optimal reserves has declined sharply since the 2002 crisis due to a substantial reduction in vulnerabilities. While the results suggest that reserves are now near optimal levels, further accumulation may be desirable going forward, partly because banks' currently high liquidity levels are likely to decline as the credit recovery matures.
 
Series: Working Paper No. 07/265
Subject(s): Foreign exchange reserves | Uruguay | Dollarization | Financial crisis | Crisis prevention

Author's Keyword(s): Foreign Reserves | Balance of Payments Crises | Sudden Stops | Bank Runs | Financial Dollarization.
 
English
Publication Date: November 01, 2007
Format: Paper
Stock No: WPIEA2007265 Pages: 24
Price:
US$18.00 (Academic Rate:
US$18.00 )
 
 
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