International Reserves and Capital Mobility

Abstract

The behaviour of holdings of official reserves in western economies has long been influenced by a theoretical approach which, while relevant to the world economy in the 1940s and 1950s, is increasingly deficient. This theoretical view was one which regarded capital movements as highly ‘disequilibrating’ and as not being part of an efficient adjustment process. This assumption was accepted as valid in the post-war period no doubt because international capital markets were imperfect and distorted, partly because of the official acceptance of the ‘disequilibrating’ hypothesis. It may be useful to contrast this dominant view with an approach which takes into account both the increasing integration of national capital markets and the monetary approach to balance of payments theory. It is the major purpose of this paper to consider some of the consequences of this ‘new’ view for domestic and international economic policy.

Priorities Review Staff, Australian Government, on leave from the Reserve Bank of Australia and the Australian National University, respectively.