The Case for an International Reserve Diversification Standard

Abstract

Rumors about the actual or potential currency diversification of countries' foreign exchange holdings out of dollars are not a new phenomenon. This working paper argues that such concerns about reserve diversification are exaggerated. We present evidence that the extent of actual diversification has been modest to date. Nevertheless, the potential for reserve diversification adds volatility to foreign exchange markets and can catalyze abrupt exchange rate movements. We argue that policymakers acting in their own national interests can do something constructive to reduce the volatility introduced into foreign exchange and financial markets by rumors of large-scale international foreign exchange reserve diversification. We propose the voluntary adoption by major foreign exchange reserve holders in particular of an International Reserve Diversification Standard consisting of two elements: (1) routine disclosure of the currency composition of official foreign exchange holdings and (2) a commitment by each adherent to adjust gradually the actual currency composition of its reserves to any new benchmark for those holdings.

Keywords: Foreign Exchange Reserves, Central Banks, International Investment and Long-Term Capital Movements, International Monetary Arrangements and Institutions

JEL Classification: F31, E58, F21, F33