Showing papers on "Foreign-exchange reserves published in 2012"

Stories of the Twentieth Century for the Twenty-First

Abstract: A key precursor of twentieth-century financial crises in emerging and advanced economies alike was the rapid buildup of leverage. Those emerging economies that avoided leverage booms during the 2000s also were most likely to avoid the worst effects of the twenty-first century's first global crisis. A discrete-choice panel analysis using 1973-2010 data suggests that domestic credit expansion and real currency appreciation have been the most robust and signicant predictors of financial crises, regardless of whether a country is emerging or advanced. For emerging economies, however, higher foreign exchange reserves predict a sharply reduced probability of a subsequent crisis.

Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems

Abstract: Contents List Of Illustrations Preface Box: Definitions Introduction The Basics Of Modern Money Theory 1. The Basics Of Macroeconomic Accounting 1.1.The Basics Of Accounting For Stocks And Flows 1.2.MMT, Sectoral Balances, And Behavior 1.3. Stocks, Flows, And Balance Sheet: A Bathtub Analogy 1.4. Government Budget Deficits Are Largely Nondiscretionary: The Case Of The Great Recession Of 2007 1.5. Accounting For Real Versus Financial 1.6. Recent US Sectoral Balances: Goldilocks And The Global Crash 2. Spending By Issuer Of Domestic Currency 2.1. What Is A Sovereign Currency? 2.2. What Backs Up Currency And Why Would Anyone Accept It? 2.3. Taxes Drive Money 2.4. What If The Population Refuses To Accept The Domestic Currency? 2.5. Record Keeping In The The Money Of Account 2.6. Sovereign Currency And Monetizing Real Assets 2.7. Sustainability Conditions 3. The Domestic Monetary System: Banking And Central Banking 3.1. Ious Denominated In The National Currency 3.2. Clearing And The Pyramid Of Liabilities 3.3. Central Bank Operations In Crisis: Lender Of Last Resort 3.4. Balance Sheets Of Banks, Monetary Creation By Banks, And Interbank Settle-Ment 3.5. Exogenous Interest Rates And Quantitative Easing 3.6. The Technical Details Of Central Bank And Treasury Coordination: The Case Of The Fed 3.7. Treasury Debt Operations 3.8. Conclusions On Fed And Treasury Roles 4. Fiscal Operations In A Nation That Issues Its Own Currency 4.1. Introductory Principles 4.2. Effects Of Sovereign Government Budget Deficits On Saving, Reserves, And In-Terest Rates 4.3. Government Budget Deficits And The 'Two-Step' Process Of Saving 4.4. What If Foreigners Hold Government Bonds? 4.5. Currency Solvency And The Special Case Of The US Dollar 4.6. Sovereign Currency And Government Policy In The Open Economy 4.7. What About A Country That Adopts A Foreign Currency? 5. Tax Policy For Sovereign Nations 5.1. Why Do We Need Taxes? The MMT Perspective 5.2. What Are Taxes For? The MMT Approach 5.3. Taxes For Redistribution 5.4. Taxes And The Public Purpose 5.5. Tax Bads, Not Goods 5.6. Bad Taxes 6. Modern Money Theory And Alternative Exchange Rate Regimes 6.1.The Gold Standard And Fixed Exchange Rates 6.2. Floating Exchange Rates 6.3. Commodity Money Coins? Metalism Versus Nominalism, From Mesopotamia To Rome 6.4. Commodity Money Coins? Metalism Versus Nominalism, After Rome 6.5. Exchange Rate Regimes And Sovereign Defaults 6.6. The Euro: The Set-Up Of A Nonsovereign Currency 6.7. The Crisis Of The Euro 6.8. Endgame For The Euro? 6.9. Currency Regimes And Policy Space: Conclusion 7. Monetary And Fiscal Policy For Sovereign Currencies: What Should Government Do? 7.1. Just Because Government Can Afford To Spend Does Not Mean Government Ought To Spend 7.2. The 'Free' Market And The Public Purpose 7.3. Functional Finance 7.4. Functional Finance Versus The Government Budget Constraint 7.5. The Debate About Debt Limits (US Case) 7.6. A Budget Stance For Economic Stability And Growth 7.7. Functional Finance And Exchange Rate Regimes 7.8. Functional Finance And Developing Nations 7.9. Exports Are A Cost, Imports Are A Benefit: A Functional Finance Approach 8. Policy For Full Employment And Price Stability 8.1. Functional Finance And Full Employment 8.2. The JG/ELR For A Developing Nation 8.3. Program Manageability 8.4. The JG/ELR And Real World Experience 8.5. The JG And Inequality 8.6. Conclusions On Full Employment Policy 8.7. MMT For Austrians: Can A Libertarian Support The JG? 9. Inflation And Sovereign Currencies 9.1. Inflation And The Consumer Price Index 9.2. Alternative Explanations Of Hyperinflation 9.3. Real-World Hyperinflations 9.4. Conclusions On Hyperinflation 9.5. Conclusion: MMT And Policy 10. Conclusions: Modern Money Theory For Sovereign Currencies 10.1. MMT Got It Right: The Global Financial Crisis 10.2. MMT Got It Right: The Euro Crisis 10.3. Creastionism Versus Redemptionism: How A Money-Issuer Really Lends And Spends 10.4. Growing Recognition Of The Need For A Job Guarantee 10.5. MMT And External Constraints: To Fix Or To Float, That Is The Question 10.6. A Meme For Money Notes Bibliography Index

Internationalization of the RMB and Historical Precedents

Abstract: The possibility that the renminbi may soon join the ranks of international currencies has generated much excitement. This paper looks to history for help in evaluating the factors deter mining its prospects. The three best precedents in the twentieth century were the rise of the dol lar from 1913 to 1945, the rise of the Deutsche mark from 1973 to 1990, and the rise of the yen from 1984 to 1991. The fundamental determinants of international currency status are econom ic size, confidence in the currency, and depth of financial markets. The new view is that, once these three factors are in place, internationalization of the currency can proceed quite rapidly. Thus some observers have recently forecast that the RMB may even challenge the dollar within a decade. But they underestimate the importance of the third criterion, the depth of financial markets. In principle, the Chinese government could decide to create that depth, which would require accepting an open capital account, diminished control over the domestic allocation of credit, and a flexible exchange rate. But although the Chinese government has been actively promoting offshore use of the currency since 2010, it has not done very much to meet these requirements. Indeed, to promote internationalization as national policy would depart from the historical precedents. In all three twentieth-century cases of internationalization, popular inter est in the supposed prestige of having the country's currency appear in the international listings

Reserve accumulation, growth and financial crises

Abstract: We present a model that reproduces two salient facts characterizing the international monetary system: i) Faster growing countries are associated with lower net capital inflows and ii) Countries that grow faster accumulate more international reserves and receive more net private inflows We study a two-sector, tradable and non-tradable, small open economy There is a growth externality in the tradable sector and agents have imperfect access to international financial markets By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth We use the model to compare the laissez-faire equilibrium and the optimal reserve policy in an economy that is opening to international capital flows We find that the optimal reserve management entails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention We also find that the welfare gains of reserve policy are large, in the order of 1 percent of permanent consumption equivalent

Expanding Central Bank Balance Sheets in Emerging Asia: A Compendium of Risks and Some Evidence

Abstract: Foreign exchange reserves have grown dramatically in emerging Asia over the past decade Many of these reserves have been sterilized, via the issuance of non-monetary liabilities by central banks, with the sterilization instruments held largely by domestic banks We investigate the effects of this process on emerging Asian economies We find evidence that long run economic performance may suffer, due to resource mis-allocation and reduced investment We also find that while reserves appear to have helped to protect banks during periods of crisis, they have had little effect during more normal times Finally, we examine the effect of reserves on central banks and monetary policy We find that sterilization appears to be incomplete in some cases, with reserves accumulation leading to higher levels of broad money, inflation and credit Further, sterilization costs, and losses due to currency appreciation, are a potential threat to central bank independence and may bias policy away from raising interest rates or allowing currency appreciationFull publication: Are Central Bank Balance Sheets in Asia Too Large?

Capital Controls with International Reserve Accumulation: Can this Be Optimal?

Abstract: Motivated by the Chinese experience, we analyze a semi-open economy where the central bank has access to international capital markets, but the private sector has not. This enables the central bank to choose an interest rate different from the international rate. We examine the optimal policy of the central bank by modelling it as a Ramsey planner who can choose the level of domestic public debt and of international reserves. The central bank can improve the saving opportunities of credit-constrained consumers modelled as in Woodford (1990). We find that in a steady state it is optimal for the central bank to replicate the open economy, i.e., to issue debt financed by the accumulation of reserves so that the domestic interest rate equals the foreign rate. When the economy is in transition, however, a rapidly growing economy has a higher welfare without capital mobility and the optimal interest rate differs from the international rate. In the Chinese context, we argue that the domestic interest rate should be temporarily above the international rate, which means that the central bank should accumulate more foreign assets than in an open economy.

On the use of sterilisation bonds in emerging Asia

Abstract: We document recent developments in the use of sterilisation bonds by six central banks in emerging Asia, and discuss the implications for monetary policy and the financial sector. An important development in the sterilisation of foreign exchange interventions in past years has been the frequent use of central banks' own paper. There has been an attempt to lengthen the maturity structure of sterilisation bills, and maturities have risen, especially in 2010-11. The choice of sterilisation instrument is likely to depend partly on their relative costs. In particular, as the yield on central bank securities has fallen relative to the rate of remuneration of required reserves, some central banks in Asia have increasingly used central bank securities for sterilisation. Keywords: sterilisation bond, central bank bonds and bills, foreign exchange reserves, emerging Asia JEL classification: E43, E50, E52, E58(This abstract was borrowed from another version of this item.)

The Federal Reserve, the Bank of England, and the rise of the Dollar as an international currency, 1914-1939

Abstract: This paper provides new evidence on the rise of the dollar as an international currency, focusing on its role in the conduct of trade and the provision of trade credit. We show that the shift to the dollar occurred much earlier than conventionally supposed: during and immediately after World War I. Not just market forces but also policy support—the Fed in its role as market maker—was important for the dollar’s overtaking of sterling as the leading international currency. On balance, this experience challenges the popular notion of international currency status as being determined mainly by market size. It suggests that the popular image of strongly increasing returns and pervasive network externalities leaving room for only one monetary technology is misleading.

The theory of an ‘optimum currency area’

Abstract: The main goal of this paper is to analyse and distinguish the main components of the theory of an ‘Optimum Currency Area’. T he theory of an optimum currency area indicates some essential elements as preconditions for the successful introduction of a common currency: high mobility of labour, openness of the economy defined as a high proportion of tradable to non-tradable goods, and high diversification of domestic production before joining the union. The article’s analysis helps to better understanding the reasons of the current crisis in the euro zone. The main problem with a common currency area is the adjustment to imbalances, which cannot take place through exchange rates in conditions of a common currency. The missing elements of the theory are the role of the mobility of capital to correct interregional balance of payments disequilibria and lack of a common budget with sufficient own resources during the occurrence of debt crises in member countries. The theory of an optimum currency area has noticed the importance of coordination between fiscal and monetary policy and the necessity of redistribution of resources among partners. However, it does not say much about the methods applied, how to deal with debt crises and what the cost of a potential breaking up of monetary union would be.

The Geographical Composition of National External Balance Sheets: 1980-2005

Abstract: This paper constructs a data set on the stocks of bilateral external assets and liabilities for eighteen countries in the period from 1980 to 2005. It distinguishes between four asset classes: foreign direct investment, portfolio equity, debt, and foreign exchange reserves. Network methods are used to explore the key facts that emerge from the data. We find that there has been a remarkable increase in interconnectivity over the past two decades and that this has been centered around a small number of countries. In a simulation exercise we show that shocks to one of the central countries generate much larger losses to the network than shocks to the periphery.

Currency Manipulation, the US Economy, and the Global Economic Order

Abstract: More than 20 countries have increased their aggregate foreign exchange reserves and other official foreign assets by an annual average of nearly $1 trillion in recent years. This buildup—mainly through intervention in the foreign exchange markets—keeps the currencies of the interveners substantially undervalued, thus boosting their international competitiveness and trade surpluses. The corresponding trade deficits are spread around the world, but the largest share of the loss centers on the United States, whose trade deficit has increased by $200 billion to $500 billion per year. The United States has lost 1 million to 5 million jobs as a result of this foreign currency manipulation. The United States must eliminate or at least sharply reduce its large trade deficit to accelerate growth and restore full employment. The way to do so, at no cost to the US budget, is to insist that other countries stop manipulating their currencies and permit the dollar to regain a competitive level. A US strategy to terminate currency manipulation, especially if undertaken together with some of the other countries that are adversely affected by the practice (including Australia, Canada, the euro area, Brazil, India, Mexico, and numerous developing countries), would be fully compatible with its international obligations. The proposed coalition should first seek voluntary agreement from the manipulators to sharply reduce or eliminate their intervention. If they do not do so, however, the United States should adopt four new policy measures against their currency activities: (1) undertake countervailing currency intervention (CCI) against countries with convertible currencies by buying amounts of their currencies equal to the amounts of dollars they are buying themselves, to neutralize the impact on exchange rates, (2) tax the earnings on, or restrict further purchases of, dollar assets acquired by intervening countries with inconvertible currencies (where CCI could therefore not be fully effective) to penalize them for building up these positions, (3) treat manipulated exchange rates as export subsidies for purposes of levying countervailing import duties, and (4) hopefully with other adversely affected countries, bring a case against the manipulators in the World Trade Organization that would authorize more wide-ranging trade retaliation. In the first instance, this approach should be taken against eight of the most significant currency manipulators: China, Denmark, Hong Kong, Korea, Malaysia, Singapore, Switzerland, and Taiwan. Japan may need to be added if it pursues new Prime Minister Abe's stated intention to force a sharply weaker yen through dollar purchases. Bergsten and Gagnon believe that cessation of intervention by these countries will permit most of the other interveners to desist as well, without their being directly approached, because much of their intervention is aimed at avoiding competitive loss to the largest manipulators (especially China).

Crisis and Calm: Demand for U.S. Currency at Home and Abroad From the Fall of the Berlin Wall to 2011

Abstract: US currency has long been a desirable store of value and medium of exchange in times and places where local currency or bank deposits are inferior in one or more respects Indeed, as noted in earlier work, a substantial share of US currency circulates outside the United States Although precise measurements of stocks and flows of US currency outside the United States are not available, a variety of data sources and methods have been developed to provide estimatesThis paper reviews the raw data available for measuring international banknote flows and presents updates on indirect methods of estimating the stock of currency held abroad: the seasonal method and the biometric method These methods require some adjustments, but they continue to indicate that a large share of US currency is held abroad, especially in the $100 denomination In addition to these existing indirect methods, I develop a framework and basic variants of a new method to estimate the share of US currency held abroadAlthough the methods and estimates are disparate, they provide support for several hypotheses regarding cross-border dollar stocks and flows First, once a country or region begins using dollars, subsequent crises result in additional inflows: the dominant sources of international demand over the past decade and a half are the countries and regions that were known to be heavy dollar users in the early to mid-1990s Second, economic stabilization and modernization appear to result in reversal of these inflows Specifically, demand for US currency was extremely strong through the 1990s, a period of turmoil for the former Soviet Union and for Argentina, two of the largest overseas users of US currency Demand eased in the early 2000s as conditions gradually stabilized and as financial institutions developed However, this trend reversed sharply with the onset of the financial crisis in late 2008 and has continued since then

Combating Widespread Currency Manipulation

Abstract: Widespread currency manipulation, mainly in developing and newly industrialized economies, is the most important development of the past decade in international financial markets In an attempt to hold down the values of their currencies, governments are distorting capital flows by around $15 trillion per year The result is a net drain on aggregate demand in the United States and the euro area by an amount roughly equal to the large output gaps in the two economies In other words, millions more Americans and Europeans would be employed if other countries did not manipulate their currencies and instead achieved sustainable growth through higher domestic demand Gagnon identifies the 20 most egregious currency manipulators over the past 11 years Four groups of countries stand out: (1) longstanding advanced economies such as Japan and Switzerland; (2) newly industrialized economies such as Israel, Singapore, and Taiwan; (3) developing Asian economies such as China, Malaysia, and Thailand; and (4) oil exporters such as Algeria, Russia, and Saudi Arabia Although currency manipulation to boost trade balances is a violation of the Articles of Agreement of the International Monetary Fund (IMF), there is currently no procedure to punish or curtail it The best forum for sanctions against currency manipulators is the World Trade Organization, operating in consultation with the IMF Countries affected by currency manipulation would be authorized to impose tariffs on imports from manipulators In order to get manipulators to agree to this change in international rules, the main targets of currency manipulation—the United States and the euro area—may have to play tough One strategy would be to tax or otherwise restrict purchases of US and euro area financial assets by currency manipulators

The expansion of central bank balance sheets in emerging Asia: what are the risks?

Abstract: Central bank balance sheets in emerging Asia expanded rapidly over the past decade because of the unprecedented rise in foreign reserve assets. The corresponding expansion of the central banks' liabilities has created dangers - risks of inflation and financial instability and financial market distortions - that require attention.

Theories of International Currencies and the Future of the World Monetary Order

Abstract: Chey, Hyoung-kyu. (2012) Theories of International Currencies and the Future of the World Monetary Order. International Studies Review, doi: 10.1111/j.1468-2486.2012.01104.x The international standings of currencies form a principal characteristic of the international monetary order, shaping the world economic and political system by influencing the economic and political relationships among countries. This paper provides a systematic review of the literature on international currencies, encompassing both economics and political science, with the aim of providing useful groundwork to help develop a better analytical framework for the study of international currency standing. In particular, this paper discusses the international currency concept, the benefits and costs of issuing an international currency, and the determinants of international currency standing. It also assesses conflicting prospects for the future of the US dollar as the world’s key currency, addressing the likelihoods of further internationalization of the euro and the renminbi, the dollar’s main potential rivals. It in addition calls attention to certain political economy factors as salient issues for the future study of international currency standing.

An econometric analysis of determinants of exchange rate in pakistan

Abstract: This study undertakes an econometric analysis of determinants of exchange rate for US Dollar in terms of Pakistani Rupee within the framework of monetary approach. Monthly data from January 1982 to April 2010 for Pakistan relative to USA have been used to examine the long run and short run behavior of PKR/USD exchange rate and relationship of exchange rate behavior with relative monetary variables. Stock of money, foreign exchange reserves and total debt of Pakistan relative to United States along with Political instability in Pakistan as a dummy variable are taken as determinants of PKR/USD exchange rate during the managed floating regime in Pakistan. ARDL approach to co-integration and error correction model are applied. Empirical results confirm that stock of money, debt and foreign exchange reserve balance all in relative terms are significant determinants of exchange rate between Pakistani Rupee and US Dollar. Moreover, Political instability has a significant negative effect on the value of domestic currency.

Global Imbalances and Foreign Asset Expansion by Developing-Economy Central Banks

Abstract: In the aftermath of the Asian financial crisis of 1997–99, central banks and governments throughout the developing world have accumulated foreign exchange reserves and other official assets at an unprecedented rate. This paper shows that this official asset accumulation has driven a substantial portion of the recent large global current account imbalances. These net official capital flows have become large relative to the size of the industrial economies, and they are a significant factor contributing to the weakness of the economic recovery in the major industrial economies.Full publication: Are Central Bank Balance Sheets in Asia Too Large?

Reserve Accumulation, Growth and Financial Crises

Abstract: We present a model that reproduces two salient facts characterizing the international monetary system: i) Faster growing countries are associated with lower net capital inflows and ii) Countries that grow faster accumulate more international reserves and receive more net private inflows. We study a two-sector, tradable and non-tradable, small open economy. There is a growth externality in the tradable sector and agents have imperfect access to international financial markets. By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth. Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy. This generates a positive link between reserve accumulation, growth and current account surpluses. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth. We use the model to compare the laissez-faire equilibrium and the optimal reserve policy in an economy that is opening to international capital flows. We find that the optimal reserve management entails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention. We also find that the welfare gains of reserve policy are large, in the order of 1% of permanent consumption equivalent.

Use of Currencies in International Trade: Any Changes in the Picture?

Abstract: The paper reviews a number of issues related to the use of currencies in international trade, more than one decade after the introduction of the euro and shortly after steps taken by the Chinese authorities to liberalize the use of the RMB in off-shore markets. Trade is an important factor in establishing a currency as an international currency, notably by fulfilling the transaction/medium of exchange and unit of account motives of currency demand. A well prepared liberalization of currency use for international trade and foreign direct investment transactions can even be helpful in achieving the international investment and reserve currency status. While in the distant past the later was also linked to preponderance of a country in trade markets, it is now linked to the prevalence of the currency in international financial transactions, which supposes that the country in question engages at least partly in some liberalization of capital account transactions. This paper shows theoretical and practical reasons explaining the current dominance of the US dollar and the euro in the invoicing of international trade. There is little doubt, though, that in the medium-to-long term the RMB will become a major currency of settlement in international trade. This is not only the current direction of government policy but also that of markets, as evidenced by the rapid expansion of off-shore trade payments in that currency. In the meantime, though, the US dollar and the euro are enjoying a near-duopoly as settlement and invoicing currencies in international trade. The stability of this duopoly is enhanced by a number of factors recently highlighted by economic analysis: coalescing, "thick externalities" and scarcity of international currencies are useful to explain that, until such time that RMB payments match at least the share of China in global trade, the US dollar and of the euro will remain the main currencies in the invoicing and payment of international trade. Section 1 looks at the factors that determine the use of currencies in the invoicing and settlement of international trade. Section 2 looks at the actual reality of currency use for international trade flows, and short-term prospects for the development of a possible alternative to the use of the US dollar and the euro (in particular in Asia), the RMB.

The Unexpected Global Financial Crisis : Researching Its Root Cause

Abstract: The world is currently still struggling with the aftermath of the worst economic crisis since the Great Depression. Following a description of the eruption, evolution and consequences of the global crisis, this paper reviews alternative hypotheses for the causes of the global financial crisis as well as their empirical evidence. The paper refutes the frequently voiced view that the global crisis was caused by global imbalances that reflected economic policies of East Asian countries. Instead, it argues that global imbalances were the result of excess demand in the United States, resulting from both the public debt in the United States arising from the Afghanistan and Iraqi wars and tax cuts and the overconsumption by households supported by the wealth effect from the housing bubble in the United States. The housing bubble itself was the outcome of the Federal Reserve's low interest rate policy in the aftermath of the burst of the "dot-com" bubble in 2001, the lack of appropriate financial regulation, and housing policies aimed at expanding the mortgage market to low-income borrowers. It was possible to maintain thelarge trade deficits of the United States for such a long period of time because of the dollar's reserve currency status. When the housing bubble in the United States burst, the global crisis ensued. The paper also analyzes why China's trade surplus increased significantly in general and with the United States in particular in recent years, and argues that this increase was caused by both the relocation of the labor-intensive tradable sector of East Asian economies to China and high corporate saving rates in China as a result of its dual-track approach to reform.

Large Excess Reserves in the U.S.: A View from the Cross-Section of Banks

Abstract: Bank reserves in the United States increased dramatically at the end of 2008. Subsequent asset purchase programs in 2009 and 2011 more than doubled the quantity of reserves outstanding. These events required major adjustments in banks' balance sheets. We study the evolution of reserve holdings across banks from the fall of 2008 until the middle of 2011 and document how banks' balance sheets changed concurrently. Motivated by the potential implications for monetary policy of operating with a high level of reserves, we focus particular attention on those banks which accumulated large quantities of reserves.

The expansion of central bank balance sheets in emerging Asia: what are the risks? 1

Abstract: Central bank balance sheets in emerging Asia expanded rapidly over the past decade because of the unprecedented rise in foreign reserve assets. The corresponding expansion of the central banks’ liabilities has created dangers – risks of inflation and financial instability and financial market distortions – that require attention.

How would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?

Abstract: In this paper we study the determinants of gross capital flows, project the size of China's international investment position in 2020, and analyze the implications for the renminbi real exchange rate if China liberalizes the capital account. We assume in this exercise that the renminbi will have largely achieved capital account convertibility by the end of the current decade, a timetable consistent with recent proposals by the People's Bank of China. Our analysis shows that if the capital account were liberalized, China's gross international investment position would grow significantly, and inflows and outflows would become much more balanced. The private sector would turn its net liability position into a balanced position, and the official sector would reduce its net asset position significantly, relative to the country's GDP. Because of the increasing importance of private sector foreign claims and the decreasing importance of official foreign reserves, China would be able to earn higher net investment income from abroad. Overall, China would continue to be a net creditor, with the net foreign asset position as a share of GDP remaining largely stable through this decade. These findings suggest that the renminbi real exchange rate would not be particularly sensitive to capital account liberalization as capital flows are expected to be two-sided. The renminbi real exchange rate would likely be on a path of moderate appreciation as China is expected to maintain a sizeable growth differential with its trading partners.

Macroeconomic impacts of foreign exchange reserve accumulation: Theory and international evidence

Abstract: Recently, a dramatic accumulation in foreign exchange reserves has been widely observed in developing countries. This paper explores the possible long-run impacts of this trend on macroeconomic variables in developing countries. We analyze a simple open economy model where increased foreign exchange reserves reduce the costs of liquidity risk. Given the amount of foreign exchange reserves, utility-maximizing representative agents decide consumption, capital stock, and labor input, as well as the amounts of liquid and illiquid external debt. The equilibrium values of these variables depend on the amount of foreign exchange reserves. A rise in foreign exchange reserves increases both liquid and total debt, while shortening debt maturity. To the extent that interest rates of foreign exchange reserves are low, an increase in foreign reserves also leads to a permanent decline in consumption. However, when the tradable sector is capital intensive, the increase may enhance investment and economic growth. We provide empirical support for our theoretical analysis using panel data from the Penn World Table. The cross-country evidence shows that an increase in foreign exchange reserves raises external debt outstanding and shortens debt maturity. The results also imply that increased foreign exchange reserves may lead to a decline in consumption, but can also enhance investment and economic growth. The positive impact on economic growth, however, disappears when we control the impact through investment.