Optimal Holdings of International Reserves: Self-Insurance Against Sudden Stop

28 Pages Posted: 14 Jul 2012 Last revised: 14 Apr 2021

See all articles by Guillermo A. Calvo

Guillermo A. Calvo

Columbia University - School of International & Public Affairs (SIPA); National Bureau of Economic Research (NBER)

Alejandro Izquierdo

Inter-American Development Bank (IDB) - Research Department

Rudy J. Loo-Kung

Inter-American Development Bank (IADB)

Date Written: July 2012

Abstract

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.

Suggested Citation

Calvo, Guillermo A. and Izquierdo, Alejandro and Loo-Kung, Rudy J., Optimal Holdings of International Reserves: Self-Insurance Against Sudden Stop (July 2012). NBER Working Paper No. w18219, Available at SSRN: https://ssrn.com/abstract=2105965

Guillermo A. Calvo (Contact Author)

Columbia University - School of International & Public Affairs (SIPA) ( email )

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National Bureau of Economic Research (NBER) ( email )

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Alejandro Izquierdo

Inter-American Development Bank (IDB) - Research Department ( email )

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Washington, DC 20577
United States

Rudy J. Loo-Kung

Inter-American Development Bank (IADB) ( email )

1300 New York Avenue NW
Washington, DC 20577
United States

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