The Financial Stability Effect of Foreign Exchange Reserves: From the Perspective of Interest Margin between Domestic and Foreign Currencies

Abstract

Abstract: From the perspective of financial openness, this paper derives the conditions of the uncovered interest parity through the scale adjustment of foreign exchange reserves, so as to provide a theoretical explanation for the financial stability effect of foreign exchange reserves from the perspective of interest margin of domestic and foreign currencies. It makes use of the annual data from 1980 to 2018 to study the foreign exchange reserves in dealing with the spillover effects of monetary policies of the major developed economies. The findings show that the foreign exchange reserves of non-international currency issuing economies can help maintain the interest margin between the local currency and the U.S. dollar, and that there exist transmission paths in foreign exchange reserves which will affect the interest margin between the local currency and U.S. dollar by triggering the changes in local currency interest rates and exchange rates. The influence of foreign exchange reserves on the interest margin between the local currency and the US dollar will be enhanced during the periods without financial crisis, and it also has a significant positive impact on the interest margin between the local currency and Euro and other SDR currencies. This impact on the interest margin between the local currency and foreign currencies is significant in the statistics of the sub-samples of the“Road and Belt”initiative economies. Therefore, it is advisable to continuously optimize the scale of foreign exchange reserves in accordance with the changes of the economic situations and the transformation of the mechanism of foreign exchange reserves, while taking into account the asset risk premium factors of the banking system.

Key words: foreign exchange reserves, interest margin between domestic and foreign currencies, financial stability

CLC Number:

F821.0

CAO Chun-yu. The Financial Stability Effect of Foreign Exchange Reserves: From the Perspective of Interest Margin between Domestic and Foreign Currencies[J]. Contemporary Finance & Economics, 2021, 0(5): 65-76.

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