What is Driving Reserve Accumulation? A Dynamic Panel Data Approach

Abstract Foreign reserve accumulation is a widespread phenomenon of recent years, particularly among emerging economies. Using a panel of 136 countries for the period 1973–2003, we demonstrate the need of using both a dynamic specification of the reserve demand equation and the system GMM estimator. These improvements change the results found by previous studies. Openness, regional imitation, persistence, an inverted U‐shaped relationship between reserves and income level, and financial deregulation are the factors driving reserve hoardings. In contrast, reserves yield, and both trade and financial volatility are not statistically significant. Surprisingly, we find that countries with flexible exchange rate regimes have higher ratios of reserves to GDP. This result is robust to alternative exchange rate regime classifications.