Does the Accumulation of International Reserves Spur Inflation? A Panel Data Analysis

Central banks’ international reserve holdings have increased significantly in the recent past. This paper assesses the consequences for monetary policy both on theoretical and empirical grounds. According to the quantity theory of money, the accumulation of reserves might result in inflationary pressures if the resulting monetary expansion is not fully sterilized and exceeds the growth of money demand. This is especially likely for countries that operate under fixed exchange rates but may also affect countries with floating rates proportionate to their individual rate of reserve accumulation. These hypotheses are tested in a panel data set of developing and industrial countries covering the period from 1970 to 2006. The evidence suggests that the accumulation of reserves increases inflation. Global reserve growth significantly raises the inflation rate with a lag of two years. This effect is especially strong for countries with fixed exchange rate regimes for which global reserve growth is found to Granger-cause inflation. A rate of global reserve growth of 1% causes an increase of the global price level of 0.25% over a period of two years. On the level of individual countries, the growth of domestic central banks assets is the major monetary determinant of inflation. The growth of reserves, however, causes inflation in a subsample including only moderate inflation rates. The degree of sterilization of the effects of reserve changes on the monetary base has changed considerably over time, with the 1970s and recent years since 2000 characterised by relatively low degrees of sterilization.