International Finance

Paper Summary:

In this article, the writer looks at the central bank, which is one of the most important institutions in a country and whose main responsibility is the national monetary policy. The writer notes that many countries can improve the efficiency of their foreign currency reserve by investing the money and generating a return. The writer also points out that, on a global level, the increased efficiency of a central bank's use of reserve would translate into a reduction of financial crises, which would allow institutions such as the International Monetary Fund to redirect its funds to countries that are not yet capable to reach financial stability as well as design policies for those countries targeting their future stability. The writer notes that these are usually third world countries or developing countries with endemic corruption and political instability.

Outline:
The Central Bank - Roles
Reserves Policy - Evidence from Developing Countries
Central Banks and Foreign Currency Reserve Policy Efficiency

From the Paper:

"A healthy reserve policy can overcome financial crises, such as those related to the country's balance sheet. Korea stands as a good example in this direction with its 1997 crisis. Investment banks started to borrowed short maturity foreign currencies and invested them in Korean won assets after the market deregulation in 1990. The same banks invested in foreign securities Russian bonds and by the end of 1997 the value of these obligations exceeded Korea's foreign currency reserves. In the context of a general fall of Asian currencies, the investors started to sell the Korean won, which eventually devaluated the national currency and forced the authorities to resort to the International Monetary Fund. The problem was not that Korean wasn't solvent, but that it wasn't liquid and this crisis could have been avoided, if the authorities hadn't let the national liquidity deteriorate so much since the beginning of 1990s."

Sample of Sources Used:

• Aizenman, J. & Marion, N. 2003. The High Demand for International Reserves in the Far East: What is Going on? Journal of the Japanese and International Economies, vol. 17(3): pp. 370-400.
• Chiodo, A. J. & Owyand, M. T. 2002. A Case Study of a Currency Crisis: The Russian Default of 1998. The Federal Reserve Bank of St. Louis, November-December: pp. 7-17.
• Feldstein, M. 1999. Self-protection for Emerging Market Economies. National Bureau of Economic Research, Working Paper 6907.
• Yardley, J. & Barbosa, D. 2007. China to Invest its Foreign Currency Reserves. International Herald Tribune, March 9, http://www.iht.com/

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