1. The Cost of Holding Foreign Exchange Reserves
- Author:
- Eduardo Levy Yeyati and Eduardo Gómez
- Publication Date:
- 05-2019
- Content Type:
- Working Paper
- Institution:
- The John F. Kennedy School of Government at Harvard University
- Abstract:
- Recent studies that have emphasized the costs of accumulating reserves for self-insurance purposes have overlooked two potentially important side-effects. First, the impact of the resulting lower spreads on the service costs of the stock of sovereign debt, which could substantially reduce the marginal cost of holding reserves. Second, when reserve accumulation reflects countercyclical LAW central bank interventions, the actual cost of reserves should be measured as the sum of valuation effects due to exchange rate changes and the local-to-foreign currency exchange rate differential (the inverse of a carry trade profit and loss total return flow), which yields a cost that is typically smaller than the one arising from traditional estimates based on the sovereign credit risk spreads. We document those effects empirically to illustrate that the cost of holding reserves may have been considerably smaller than usually assumed in both the academic literature and the policy debate.
- Topic:
- Financial Crisis, Exchange Rate Policy, International Reserves, and Capital Flows
- Political Geography:
- Global Focus and United States of America