Prolonged reserves accumulation, credit booms, asset prices and monetary policy in Asia

BIS Working Papers No 500
April 2015

This paper examines past evidence of prolonged periods of foreign exchange reserves accumulation in the Asia-Pacific region. One empirical challenge is to identify periods of reserve accumulation that are sufficiently large and persistent to be categorised as prolonged. Several proxies for prolonged episodes are considered, including a newly proposed one based on a factor model. We then identify the key macrofinancial determinants of prolonged reserve accumulation. Two broad conclusions emerge from the stylised facts and the econometric evidence. First, the best protection against costly reserves accumulation is a more flexible exchange rate. Second, the necessity of accumulating reserves as a bulwark against goods price inflation is misplaced. Instead, there is a strong link between asset price movements and the likelihood of accumulating foreign exchange reserves that are costly. Policy implications are also drawn.

JEL classification: F41, F32, E44, D52

Keywords: foreign exchange reserves accumulation, monetary and financial stability