Can governments sleep more soundly when holding international reserves? A banking and financial vulnerabilities perspective*

Abstract

We use a sample of 40 developing and emerging countries over the period 1995-2015 to assess the effectiveness of international reserve holding as a crisis mitigator. We test the relevance of the reserve accumulation decreasing returns assumption by estimating the most recent version of the PSTR model. We find that increasing stocks of international reserves allows domestic authorities to mitigate the negative impacts of financial and banking vulnerabilities on GDP growth rates leading to reject the decreasing returns assumption. This evidence is robust to sensitivity checks.