Central Bank Balance Sheets and Foreign Exchange Rate Regimes : Understanding the Nexus in Asia

Central bank balance sheets in emerging Asia have been expanding rapidly for the past decade, driven primarily by the accumulation of foreign exchange reserves. Some of the expansion reflects efforts to increase the buffer stock of reserves in the aftermath of the 1997–98 Asian Financial Crisis. Increasingly, however, the reserve accumulation has been the by-product of exchange rate regimes that have in practice tended to resist appreciation. At the same time, policymakers in the region have been able to achieve price stability and bolster financial stability.This policy experience in Asia is changing the consensus about the trade-off between fixed and floating exchange rate regimes. The past decade has shown that an intermediate approach in Asia has emerged as being both feasible and, by revealed preference, desirable. But this choice however is not without its costs. The unprecedented expansion in the region's central bank balance sheets has increased the carrying cost for central banks and exposed them to significant re-valuation risks as exchange rates and interest rates fluctuate. This paper also introduces concerns about the rise of ‘lazy assets' on the balance sheets of private sector financial institutions. These assets are associated with the sterilization purchases of foreign exchange assets by central banks which, over time, could contribute to financial instability. Conclusions are drawn about the need for more sustainable Asian monetary policy and exchange rate regimes.Full publication: "http://ssrn.com/abstract=2166373" Are Central Bank Balance Sheets in Asia Too Large?