Understanding the Recent Surge in the Accumulation of International Reserves

This paper looks at the empirical determinates of foreign currency reserve holdings across a panel of around 130 countries between 1980 and 2008. The paper builds on the existing literature by adopting a panel error-correction model specification and by extending the sample to include the recent period that saw a continuing acceleration in the accumulation of reserves in many countries. The results of the analysis suggest that the levels of trade and domestic financial depth are robust determinates of the level of reserves in the long run, particularly over the past decade and a half. The estimations also find that changes in GDP, the exchange rate regime, exchange rate volatility, and financial openness can all have permanent one-off effects on the level of reserves. Furthermore, country fixed effects are found to be significant, suggesting that time-invariant country specific factors are important in explaining the variance in reserve holdings across countries. Nevertheless, several countries stick out in terms of holding reserves well in excess of that implied by these empirical results, above all in recent years. Among these countries, China and Japan are particularly notable, especially when the deviation from average behaviour is expressed in dollar terms.