Macroeconomic considerations in regional reserve pooling

Traditional approach to optimal reserve determination centres on reserves as adjustments to shocks to the balance of payments. The demand for reserves varies according to the international interest rates, volatility of the terms of trade and the exchange rate regimes (Garcia, 1999). While precautionary motive (Aizenman and Lee, 2005; Li and Rajan, 2005) continues to dominate the changing motive of reserve accumulation in East Asia, the literature on optimal reserve allocation has shifted to the strategic issue of reserve pooling (Rajan and Siregar, 2002; Wan, 2005, 2006), to mobilize the vast pool of reserves exceeding the optimal level for regional investment in East Asia. Using cointegration analysis to determine the key macroeconomic variables such as import-reserve ratio, trade openness, short-term indebtedness, volatility of exports, net capital inflow as well as the interest rate spread between US Treasury rates and regional average lending rates, this article attempts to develop a regional framework for reserve currency pooling as liquidity support for the newly established ASEAN Plus Three (APT; China, Korea and Japan) in the Chiang Mai Initiative (CMI) in May 2000. The benefits and costs of reserve pooling are analysed, taking into consideration its welfare implications with and without including Australia as the potential member of APT in the distant future.