Essays on Foreign Exchange Reserves in Developing Countries

The thesis examines the determinants, benefits and macroeconomic implications of foreign exchange reserves in developing countries. It has three main essays. Using data from sub-Saharan Africa, the first essay investigates the determinants of foreign reserves through an econometric approach and contrasts the results with those existing in the literature that have been drawn by largely employing data from the emerging market economies of Asia, where accumulation of reserves has been extraordinarily high. The second essay, examines the role of foreign reserves in mitigating the negative effects on growth of external shocks faced by economies from sub-Saharan Africa by identifying an additional benefit of holding reserves; namely that holding reserves helps mitigate the effects of commodity price shocks and foreign aid shocks. A sizeable level of reserves may mitigate these shocks by providing a buffer of funds to compensate for the loss of income through severe aid decreases or loss of export revenue. Using a cointegrating panel approach, the data provides evidence suggesting that foreign reserves mitigate the effects of commodity export price shocks and aid shocks and this result is robust to the addition of flexible exchange rate as an additional mitigation instrument. The third essay investigates the inflationary effect of foreign reserves accumulation on the domestic economy. A dynamic panel data approach is used on a sample of 70 developing countries to examine the empirical relationship between changes in international reserves and inflation. The results suggest that changes in foreign reserves are positively related with changes in the price level. This result is robust across country sub-groupings and monetary regimes.