## Is SDR Creation Inflationary?

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### Purpose and framing
- Addresses whether more frequent and significant allocations of SDRs would be inflationary for the world economy.
- Explores five scenarios describing how recipient countries and leading central banks (notably the U.S. Federal Reserve (FRB) and the European Central Bank (ECB)) would respond.
- Conclusion: SDR issuance would be inflationary under two scenarios, but not under the remaining three scenarios, which include the most likely ones.

### Key mechanics of SDR creation and use
- SDRs are issued by the International Monetary Fund (IMF) to members in proportion to each country’s quota at the IMF.
- Allocations per se have no immediate monetary effect; they provide participants’ monetary authorities with an additional contingent claim on SDR Department participants.
- Use of SDRs requires a balance of payments or reserve position need (Article XIX.3).
- A country uses SDRs by exchanging them for a “freely usable currency” (overwhelmingly U.S. dollars or euros).
- If dollars or euros are provided by countries other than the United States or Eurozone members, there is no monetary effect (reserves are transferred).
- If the United States supplies dollars via the Treasury’s Exchange Stabilization Fund (ESF), initially there is no Federal Reserve credit creation; only if the ESF lacks sufficient dollars will it sell the SDRs to the Federal Reserve, creating Federal Reserve credit.
- If a Eurozone member provides euros, credit is created within the euro zone; the ECB automatically sterilizes creation if it exceeds that desired by the ECB.

### Magnitudes and illustrative arithmetic
- World money supply (M2) at end-2009: approximately $45 trillion.
- Each $100 billion allocation of SDRs, if converted entirely into domestic currencies, would increase the world money supply by 0.22 percent.
- $200 billion (roughly 133 billion SDRs) would be twice that (i.e., 0.44 percent of world M2).
- U.S. share of a $100 billion allocation: $17 billion, equivalent to 0.2 percent of U.S. M2 at end-2009 (1.0 percent of M1).
- If SDRs were converted into bank reserves and allow multiple expansion, in the United States this could allow a roughly ten-fold expansion in bank loans, or an increase of 2 percent of M2, compared with a normal annual increase (1997 to 2007) of 6.4 percent a year.
- During the six months following the August 2009 allocations, about SDR 3.1 (roughly $4.6 billion), under 2 percent of the total allocation, were sold for usable currencies; 97 percent of those sales were dollars and euros. Thirteen countries sold nearly their total allocation; three additional countries made partial sales.

### Behavioral observations about likely responses
- Large advanced economies (United States, Canada, Japan, western Europe, and China) together account for 62 percent of IMF quotas and would likely not change macroeconomic policies in response to additional SDRs.
- It is unclear whether the 2009 pattern of limited sales (under 2 percent sold) would persist if SDRs were issued regularly.

### Five scenarios of response (enumerated findings)
1) All countries simply hold SDRs or use them to repay IMF obligations; no influence on economic behavior.
   - Result: no inflationary impact from public action.
   - Subcase: private agents reduce precautionary money balances because of higher official reserves, increasing velocity — unlikely and contingent on FRB/ECB behavior.
2) All recipients increase domestic credit by the full amount of the SDR allocation (or more).
   - Example: a $100 billion allocation could increase world money supply by 0.2 percent or perhaps even two percent.
   - Result: could be inflationary if increased money supply raises expenditures or anticipatory price increases; presumes weak or abandoned inflation targeting globally.
3) Countries substitute SDR allocations for dollars or other foreign currencies they otherwise would have added to reserves.
   - SDRs replace actions such as borrowing abroad or running current account surpluses.
   - Permits greater domestic credit expansion and investment, and a decline in current account balances relative to what would otherwise have occurred.
   - Net global effect: larger export demand in other countries (notably Europe and the United States), reduced demand for dollars/euros among some countries.
   - FRB and ECB would reduce supply of dollars/euros to match reduced demand and would offset any inflationary impact via monetary policy; result: increased inflationary pressures in many countries mitigated by central bank actions and increased imports.
   - Domestic effects: possible price increases for nontradables and real appreciation or inflation in the SDR-spending country.
4) Variant of (3): countries use SDRs to increase domestic expenditure by central bank issuance of domestic currency to the government against SDRs, while not reducing foreign currency holdings.
   - Effect: increased domestic spending and imports, raising export demand in other countries.
   - FRB, ECB, and Bank of England would respond to any inflationary pressures to keep inflation within targets.
   - Outcome: no additional inflation in the core of the world economy except via higher raw material prices.
5) Variant of (3)/(4) where the FRB and/or ECB fail to respond to inflationary pressures.
   - Possible justifications: weak global demand (e.g., recession) where expansionary demand from SDR recipients does not produce price increases beyond raw materials.
   - Author’s judgment: extremely improbable that FRB or ECB would abandon inflation-fighting because of SDR allocations.

### Conclusion and policy implication
- The most likely outcomes are combinations of scenarios (3) and (4).
- Any possible global inflationary impact from increased import demand by developing countries following an allocation of SDRs would be fully neutralized by the monetary policies of the Federal Reserve, the European Central Bank, and other inflation-targeting central banks.
- It is unlikely that additional SDR allocations would by themselves undermine inflation-targeting by major central banks.

### Annex — Mechanics of SDR absorption (summarized)
- Allocation to the United States and Eurozone members does not directly affect monetary policy; effects occur when a country exchanges SDRs for dollars or euros via the IMF.
- United States: SDRs presented to the U.S. Treasury’s ESF; ESF dispenses dollars from its balances if possible. If ESF dollar balances are inadequate, it can sell SDRs to the Federal Reserve, which creates Federal Reserve credit (increases money supply). Such credit can and normally would be sterilized through the Fed’s normal open market operations (e.g., selling an equivalent amount of U.S. Treasury bills).
- Eurozone: SDRs presented to national central banks in exchange for usable currencies; transactions reported to the ECB. If euros are provided, the ECB allows that issuance by adjusting its frequent repurchase operations.

*Report by Richard Cooper, Harvard University, as Independent External Consultant*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2011/_010711a.pdf_