The Demand for International Reserves and Monetary Equilibrium: Some Evidence From Developing Countries

TLDR: In this article, the authors empirically integrate two alternative explanations for the behavior of international reserves through time: monetary factors and differences between actual and desired reserves, and show that the exclusion of monetary factors from the dynamic analysis of international reserve movements will yield biased coefficients.

Abstract: Traditionally, two alternative explanations have been offered for the behavior of international reserves through time. On the one hand, the literature on the demand for international reserves postulates that reserves movements respond to discrepancies between desIred and actual reserves. Onthe other hand, according to the monetary approach to the balance of payments,changes in international reserves will be related to excess demands or excess supplies for money. The purpose of this paper is to empirically integrate these two basic explanations for international reserves movements. This is done by estimating a dynamic equation that explicitly allows reserves movements to reflect the monetary authority's excess demand for international reserves, and the public's excess demand for money. The results obtained,using a sample of 23 developing countries that maintained a fixed exchange rate during period 1965-1972, confirm the hypothesis that reserves movements respond both to monetary factors and to differences between actual and desired reserves. These results indicate that the exclusion of monetary considerations from the dynamic analysis of international reserves will yield biased coefficients.