International reserves and domestic money market disequilibrium
- 2 December 2019
- journal article
- research article
- Published by Emerald in International Journal of Emerging Markets
- Vol. 14 (5), 1081-1101
- https://doi.org/10.1108/ijoem-10-2018-0536
Abstract
The purpose of this paper is to examine the likely determinants of the demand for official international reserves (hereafter reserves) for India and China in the long run in a basic buffer stock model. The paper also examines the role of domestic money market disequilibrium in the short-run demand for official reserves for both the countries in a dynamic synthesis model. The study used quarterly data for the time period 1993:Q1–2015:Q4. The long-run model is being estimated by following the Frenkel–Jovanovic (1981) buffer stock model and includes the determinants such as transaction motive variable (GDP or Imports), opportunity cost variable (domestic interest rate), precautionary motive variable (volatility of reserves) and exchange rate. The study also examined the role of domestic money market disequilibrium in addition to the above variables in the short-run reserve demand model. The money market disequilibrium term is expected to be negative and significant in the short run. The study employed autoregressive distributed lag bound testing approach to co-integration and unrestricted error-correction model (UECM) approach developed by Pesaran et al. (2001) for estimating the long-run and short-run models, respectively. The co-integration test suggests the existence of long-run relationship between international reserves and its determinants. In the long run, all the variables are statistically significant with expected sign, except domestic interest rate variable for China. It is also found that, the money market disequilibrium term in the short run is negative and significant which validates that an excessive money demand (supply) induces an inflow (outflow) of international reserves for both India and China with a lag of four quarters. The recursive residual tests (CUSUM and CUSUMSQ) confirm the stability of both long-run and short-run reserve demand models. The findings and policy implications of this study may be useful for the policy makers of the similar emerging economies for designing money and currency policies. This paper is a comparative study which systematically analyzed the reserve demand behavior of the two emerging economies India and China. The study integrates the domestic money market with the international reserve demand behavior for these two economies.Keywords
This publication has 43 references indexed in Scilit:
- Precautionary and mercantilist approaches to demand for international reserves: an empirical investigation in the Indian contextMacroeconomics and Finance in Emerging Market Economies, 2009
- The dynamic relationship between real exchange rates, real interest rates and foreign exchange reserves: empirical evidence from ChinaApplied Financial Economics, 2006
- Rethinking Fast Growth in China's Foreign Exchange ReservesChina & World Economy, 2006
- Austria's Demand for International Reserves and Monetary Disequilibrium: The Case of a Small Open Economy with a Fixed Exchange Rate RegimeEconomica, 2004
- Bounds testing approaches to the analysis of level relationshipsJournal of Applied Econometrics, 2001
- THE POWER OF COINTEGRATION TESTSOxford Bulletin of Economics and Statistics, 1992
- Generalized autoregressive conditional heteroskedasticityJournal of Econometrics, 1986
- The Demand for International Reserves and Exchange Rate Adjustments: The Case of LDCs, 1964-1972Economica, 1983
- The Square-Root Law of Precautionary ReservesJournal of Political Economy, 1971
- The Transactions Demand for Cash: An Inventory Theoretic ApproachThe Quarterly Journal of Economics, 1952