EXCHANGE-RATE REGIMES AND INTERNATIONAL RESERVES

Abstract

In this paper, we use the new classification of exchange-rate arrangements developed by Reinhart and Rogoff (2004) to test whether reserve holdings decrease with increasing exchange-rate flexibility. Using pooled data for 127 countries over the period 1980–2000, we find several new results. First, the degree of exchange-rate flexibility has an inverted-U relationship with the country’s reserve holdings. Exchange-rate regimes with intermediate flexibility need more reserves than polar regimes (hard pegs and freely floating). Second, reserve holdings are smaller under hard pegs than under freely floating, implying that current large stockpiles of reserves in East Asian countries can be significantly reduced if they adopt a single currency. Finally, per capita GDP and reserve holdings have an inverted-U relationship, too, reflecting that their correlation would be negative for industrial countries, but positive for developing countries.