Working Paper: NBER ID: w30891
Authors: Joshua Aizenman; Syhoa Ho Luu; Duc Toan Huynh; Jamel Saadaoui; Gazi Salah Uddin
Abstract: The global financial crisis has brought increased attention to the consequences of international reserves holdings. In an era of high financial integration, we investigate the relationship between the real exchange rate and international reserves using nonlinear regressions and panel threshold regressions over 110 countries from 2001 to 2020. Our study shows the level of financial-institution development plays an essential role in explaining the buffer effect of international reserves. Countries with a low development of their financial institutions may manage the international reserves as a shield to deal with the negative consequences of terms-of-trade shocks on the real exchange rate. We also find the buffer effect is stronger in countries with intermediate levels of financial openness.
Keywords: International Reserves; Real Exchange Rate; Financial Integration; Threshold Effects
JEL Codes: F30; F40; F44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| International reserves (F31) | Real exchange rate volatility (F31) |
| International reserves > 17% of GDP (F31) | Buffer effect of international reserves (F31) |
| Financial institution development (O16) | Effectiveness of reserves as a buffer (H12) |
| Financial institution development (slower) (O16) | Reserves as a shield against negative shocks (F31) |
| Financial openness (intermediate levels) (F30) | Buffer effect of reserves (F31) |
| Financial openness (low/high) (F65) | Diminished protective role of reserves (F52) |