Description

This paper analyzes the rationale for hoarding international reserves. Reserves are used as a form of insurance against external financing shocks and also to influence the exchange rate. Here I argue that separating the two objectives is not possible. This is why other types of insurance, although potentially cheaper, are not of widespread use. Meanwhile, the fact that in practice the use of reserves is very low even during crises is proof that they play a rather deterrent role, in the sense that the sole act of having them reduces financial vulnerability. Evidence from the subprime crisis shows that countries with higher levels of reserves suffered less financial stress. I also discuss various ways of measuring the adequate level of reserves, illustrated with evidence for Chile, together with examining variations in reserves and in the exchange rate during the Asian crisis and the subprime crisis.