International reserves: self-insurance and monetary policy in crisis

Abstract

Purpose

This work presents a model of a two-period economy to discuss the link between the precautionary motivation for holding international reserves and the country's monetary policy concerns due to a crisis.

Design/methodology/approach

There are two possible states of nature in the second period of the economy: a normal state and a crisis state. These states of nature represent uncertainty to the policy maker and he can insure against a crisis. The household has a constant-elasticity-of-substitution (CES) utility function, where utility depends on consumption and money.

Findings

By allowing money in the utility function and in the household financial constraint and considering that the objective of the central bank is to smooth inflation, it is concluded that monetary policy plays a role in the precautionary motivation of holding international reserves.

Practical implications

The model can be used to calculate optimal reserves holdings in its complete or even in its simplified version. Furthermore, it is possible to evaluate the impact of the intra-temporal substitution elasticity between consumption and real money in the decision of accumulating international reserves.

Originality/value

Higher intra-temporal substitution elasticities implies in more insurance via international reserves, and this discussion is not found in the existent literature on international reserves.

Citation

Silva Junior, A.F.d.A.d. (2021), "International reserves: self-insurance and monetary policy in crisis", International Journal of Emerging Markets, Vol. 16 No. 8, pp. 1677-1696. https://doi.org/10.1108/IJOEM-09-2019-0677