Chapter 7: Concluding remarks
The global financial system requires that the central bank hold foreign exchange worth a certain number of months of import cover. It does not matter the nature of the foreign exchange rate regime. This import cover is necessary if the economy is to credibly pay its bills internationally. The central bank buys foreign currencies in the domestic foreign exchange market because it has to pay for the currencies with the money it has the capacity to print and supply. Therefore the long-term growth of foreign currency reserves implies a long-term level of excess non-remunerated reserves will be held in the domestic banking system. The implication here is excessive bank liquidity has more to do with the structure than risks or volatility, which often clusters while excess liquidity stays persistently high, owing to the liquidity preference of banks. As the central bank accumulates foreign exchange reserves, the stock available to commercial banks is diminished. This is the foreign currency constraint in a financial context. The constraint is reflected in a mismatch between the desire of commercial banks to hoard foreign currency assets and the available supply of foreign exchange in the same time period. Therefore to prevent the banks from pressuring the exchange rate downward, the central bank has to institute a compensation mechanism, which involves the sale of interest bearing Treasury bills (or some other government paper) to ‘mop up’ the excess reserves.
You are not authenticated to view the full text of this chapter or article.
Elgaronline requires a subscription or purchase to access the full text of books or journals. Please login through your library system or with your personal username and password on the homepage.
Non-subscribers can freely search the site, view abstracts/ extracts and download selected front matter and introductory chapters for personal use.
Your library may not have purchased all subject areas. If you are authenticated and think you should have access to this title, please contact your librarian.