Central bank holdings of foreign exchange reserves : why have they grown so fast?

Abstract

The first decade of the twenty-first century witnessed an historically unprecedented rise in the quantity of assets held as foreign exchange reserves by central banks. The locus of this rise has been in east Asia. By analyzing the change in reserve accumulation behavior which followed the financial crises that swept the globe in the late 1990s, this paper puts forth an explanation of the rise in East Asian reserve holdings based on increased sensitivity to perceived crisis risk by the Asian "Tigers" (including Japan and China). Our findings indicate that not only are reserve holdings worldwide higher since the end of the 1990s in real terms, but that the increase in East Asian reserve holdings has outpaced the rest of the world by a factor of 6. Empirical results corroborate the hypothesis that the relevant channel of influence for this change is through the interaction of exchange rate policy-specifically, a "fixed" exchange rate regime-and the extent to which a country engages in international trade.