How central banks prepare for financial crises - An empirical analysis of the effects of crises and globalisation on international reserves

Abstract

Central banks' international reserve holdings have increased significantly in the recent past. While traditional models fail to explain this accumulation of reserves, the more recent literature argues that reserves are used as a lifejacket against financial crises. However, research so far has neglected the question whether and how central banks change their precautionary reserve holdings after the country was affected by a financial crisis. This paper tests the hypothesis that central banks revise their reserve policy in the aftermath of financial crises. Static and dynamic panel data models are estimated for emerging and developing countries covering the period 1970-2010. The evidence suggests that currency crises induce a permanent increase of reserves. This effect is particularly strong for recent currency crises since the Asian financial crisis of 1997-1998. With less robustness, banking crises also induce a positive shift of the reserve level. (C) 2012 Elsevier Ltd. All rights reserved.