1. Demand for International Reserves
Ji Kim

2. Demand for International Reserves
The bank’s assets
Domestic government bonds
International reserves
Role of International Reserves
Can be traded to foreigners for goods
Help on financial crises
When the value of domestic assets decrease

3. Basic Model Assumptions
Domestic and foreign bonds are perfect substitute
Exchange rate is fixed
Absolute confidence in the fixed EXRA
Individual central banks can acquire all the international reserves they need
Monetary policy is ineffective

4. Gold Standard Gold has been treated as international asset
Debate whether the U.S.D. can play role as international asset today
Euro is the strongest challenger to the dollar

5. Benefit of Holding International Reserves
International reserves utilized to cover a sudden drop in export earnings

6. Influences to Demand on International Reserves
The variability levels of exports, imports, and international financial flow
Thus, higher economic openness leads to lower demand for international reserves
Openness makes adjustments easier
On the other hand, higher openness might cause an economy to become more vulnerable which will increase the demand
Foreign trade shock

7. Cost of Holding International Reserves
Loss of interest on the domestic bonds
Earns the interest on dollars instead
International reserves may offer lower interest rate due to their higher liquidity

8. Flexible Exchange Rates and Demand for International Reserves
In 1960s, theoretically countries with more flexible exchange rate could generate export surplus with low running international reserves
Theoretically, they could depreciate their currencies to avoid recession
In early 1970s, the industrial countries moved to floating exchange rate
Economists expected that demand for the reserves would drop substantially

9. However, industrial-country reserves have grown as the same pace as the nominal industrial-country income

10. , the sharp decline in developing-country reserve is influenced by an international debt crisis during the years
Developing country with flexible EXRA might need to pay off foreign creditors and domestic residents with dollar to avoid a financial crisis and currency collapse

11. The Variability and Demand for International Reserves
The variability in the balance of payment still influence the demand for international reserves.
Today's, huge increase in potential variability and in the potential risks of variability
Caused by rapid globalization of financial markets in recent years