Optimal Holdings of International Reserves Self-Insurance Against Sudden Stop

Resumen

This paper addresses the issue of the optimal stock of international reserves in terms of a statistical model in which reserves affect both the probability of a Sudden Stop–as well as associated output costs–by reducing the balance-sheet effects of liability dollarization.  Optimal reserves are derived under the assumption that central bankers conservatively choose reserves by balancing the expected cost of a Sudden Stop against the opportunity cost of holding reserves. Results are obtained without using calibration to match observed reserves levels, providing no a priori reason for our concept of optimal reserves to be in line with observed holdings.  Remarkably, however, observed reserves on the eve of the global financial crisis were–on average–not distant from optimal reserves as derived in this model, indicating that reserve over-accumulation in Emerging Markets was not obvious.  However, heterogeneity prevailed across regions: from a precautionary standpoint, Latin America was closest to model-based optimal levels, while reserves in Eastern Europe lay below optimal levels, and those in Asia lay above.  Nonetheless, there are other motives for reserve accumulation: we find that differences between observed reserves and precautionary-motive optimal reserves are partly explained by the perceived presence of a lender of last resort, or characteristics such as being a large oil producer.  However, to a first approximation, there is no clear evidence supporting the so-called neo-mercantilist motive for reserve accumulation.