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Foreign Reserves, Bilateral Currency Swap and Liquidity Shock

【Authors】
YANG Quan, YANG Qiuju
【WorkUnit】
Xiamen University, 361005.
【Abstract】

This paper proposes a model of liquidity shock which aims at alleviating the impact of capital flow sudden stop with foreign reserves and bilateral currency swap in open macroeconomic circumstances, and explores the effect of foreign reserves and bilateral currency swap on the expected surplus created by international capital. We also show the optimal ratios of foreign reserves to bilateral currency swap lines responding to different liquidity shocks by parameter setting and simulation. The results show that, when the liquidity shock of international capital is less than 0.5, the optimal ratio of foreign reserves to international capital is about 24.1%, which can handle most of the financial liquidity crisis; when the liquidity shock of international capital ranges between 0.51 and 0.87, the best way is to combine foreign reserves and bilateral currency swap. Therefore, the corresponding intervals of the optimal ratios of foreign reserves and bilateral currency swap lines to international capital stand at 24.18%~25.55% and 0.33%~35.54%, respectively. Comparing the above outcomes to the bilateral currency swap lines from China and from Federal Reserve, we discover that the scale of foreign reserves and swap lines in the agreements falls into the optimal interval in the model, but the majority of the countries cannot cope with the liquidity shock above 0.6. In other words, most countries had inadequate reserves; only Brazil, Denmark, Japan, Republic of Korea, Russia and Thailand had adequate reserves when signing the swap agreements. Besides, the bilateral currency swap lines in the agreements between China and Kazakhstan, Turkey and Serbia are too low to provide adequate liquidity in case of a crisis.

 
JEL:.F37, F41

【KeyWords】
Liquidity Shock of International Capital, Foreign Reserves, Bilateral Currency Swap, Welfare Effect, Optimal Interval