Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefit Analysis

By Era Dabla-Norris, Jun I Kim, Kazuko Shirono

October 1, 2011

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Era Dabla-Norris, Jun I Kim, and Kazuko Shirono. Optimal Precautionary Reserves for Low-Income Countries: A Cost-Benefit Analysis, (USA: International Monetary Fund, 2011) accessed September 18, 2024

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 develops a cost-benefit approach that helps to quantify the optimal level of international reserves in low-income countries, focusing on the role of reserves in preventing and mitigating absorption drops triggered by large external shocks. The approach is applied to a sample of 49 LICs over the period 1980-2008 to yield estimates of the likelihood and severity of a crisis. The calibration results suggest that the standard metric of three months of imports is inadequate for countries with fixed exchange rate regimes. The results also highlight the role of overall policy frameworks and availability of Fund-support in determining optimal reserve levels, raising questions about the uniform applicability of standard rules of thumb across countries.

Subject: Central banks, Conventional peg, Exchange rate arrangements, Exchange rate flexibility, Financial crises, Foreign exchange, Imports, International trade, Reserve positions

Keywords: Africa, Commodity exporter, Conventional peg, Cost-benefit framework, Demand regression, Exchange rate arrangements, Exchange rate flexibility, Exchange rate regime, Holdings reserve, IMF program, Imports, Low-income countries, Opportunity cost, Optimal level of reserves, Optimal reserve, Precautionary reserves holding, Reserve adequacy, Reserve coverage, Reserve positions, WP

Publication Details

Pages:

35
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2011/249
Stock No:

WPIEA2011249
ISBN:

9781463923280
ISSN:

1018-5941

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