International Reserves

• Author: Jaewoo Lee
• Pages: 1-6

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International reserves are at the core of the IMF work: the change in international reserves over time reflects the net flow in the balance of payments, and a minimum level of net international reserves is an important element of IMF conditionality. Measurement of international reserves needs to be kept current and relevant, especially in light of the globalization of financial markets and the development of new financial instruments. The IMF's most recent guidelines on how to measure reserves are summarized by Kester (2000). Two core criteria for classifying external assets as reserves are to be "readily available to" and "controlled by" the monetary authorities.

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International Reserves

The new guidelines also seek to ensure that statistics on international reserves- deemed critical for preventing financial crisis-are transparent in the face of a plethora of financial derivatives and off-balance-sheet activities.

Measured properly, what long-term trend have international reserves been exhibiting? The answer, according to Flood and Marion (2002), is a steady increase. In percent of world GDP, international reserves increased threefold between the early 1960s and the late 1990s. While greater financial volatility over the last decade may have contributed to this upward trend, econometric estimates by Flood and Marion show that buffer-stock models explain only a small portion of reserves volatility during the Bretton Woods as well as the floating exchange rate period.

Taking a more eclectic approach, Edison (2003) uncovers several variables that are closely correlated with international reserves in a cross section of countries. Over the 1980s and 1990s, international reserve holdings of individual countries were positively associated with economic size (both income and population) and current account vulnerability (measured by the ratio of imports to GDP), and negatively associated with exchange rate volatility. Going beyond reduced-form correlations, Hviding, Nowak, and Ricci (forthcoming) find that a higher level of reserves contributes to lowering exchange rate volatility-through a signaling channel-even after controlling for differences in exchange rate regimes.

Indeed, a key reason for holding international reserves has been to stabilize the exchange rate through intervention in the foreign exchange market. Canales-Kriljenko and others (2003a, 2003b) examine current...