IS IT POSSIBLE TO REDUCE THE STOCK OF FOREIGN RESERVES?

Year 2011, Volume: 3 Issue: 2, 193 - 205, 01.12.2011

Marcello Spanò

Abstract

This work determines the optimal reserves to short term debt ratio of an exporting
economy indebted in foreign currency and suggests possible remedies to reduce it.
Theoretical results and numerical simulations establish that the ratios recently
observed reflect the increasing weight assigned to the risk of firms going
bankrupt. They also establish that neither a lower risk premium charged by
international lenders nor a lower exchange rate volatility reduce the stock of
reserves significantly. Full elimination of the need to hold reserves to prevent
financial crises should rely either on limiting foreign capital inflow or on
reforming the international monetary system.

Keywords

reserves, short term debt, exchange rate, financial distress, bankruptcy, hedging

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