The Optimal Level of Foreign Reserves in Financially Dollarized Economies: The Case of Uruguay

November 1, 2007

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Fernando M. Gonçalves The Optimal Level of Foreign Reserves in Financially Dollarized Economies: The Case of Uruguay, (USA: International Monetary Fund, 2007) accessed December 26, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This paper extends the framework derived by Jeanne and Rancière (2006) by explicitly incorporating the dollarization of bank deposits into the analysis of the optimal level of foreign reserves for prudential purposes. In the extended model, a sudden stop in capital flows occurs in tandem with a run on dollar deposits. Reserves can smooth consumption in a crisis but are costly to carry. The resulting expression for the optimal level of reserves is calibrated for Uruguay, a country with high dollarization of bank deposits. The baseline calibration indicates that the gap between actual and optimal reserves has declined sharply since the 2002 crisis due to a substantial reduction in vulnerabilities. While the results suggest that reserves are now near optimal levels, further accumulation may be desirable going forward, partly because banks' currently high liquidity levels are likely to decline as the credit recovery matures.

Subject: Bank deposits, Central banks, External debt, Financial crises, Financial services, Foreign currency debt, International reserves, Reserve positions, Reserves accumulation

Keywords: Balance of Payments Crises, Bank deposits, Bank Runs, Crises prevention role, Deposit, Deposit dollarization, Deposit withdrawal, Dollar deposit, Dollar-denominated deposit, Financial Dollarization, Foreign currency, Foreign currency debt, Foreign currency deposit, Foreign currency lines of credit, Foreign Reserves, GDP, International reserves, Reserve positions, Reserves accumulation, Rollover crisis, Sudden Stops, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2007/265
Stock No:

WPIEA2007265
ISBN:

9781451868289
ISSN:

1018-5941

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