It is widely agreed that the primary objective of any reform of the international arrangements on the supply of reserves should be to establish control over the global volume of liquidity, with a view to ensuring that such control will be conducive to stable growth of the world economy. However, the long-standing academic discussion of “seigniorage,” the practical concern of national officials to safeguard the interest earnings on their reserves, and the campaign by the developing countries to establish a link, all attest to the importance of the financial implications arising from the selection of a set of reserve supply arrangements. This is the subject explored in the present paper.
The financial effects of reserve supply arrangements are demonstrated by a simple model which relates the income accruing to a country from the processes of reserve holding and reserve creation to the policies adopted by the country and to the arrangements adopted by the international community. The various arrangements analyzed are those discussed during the negotiations on world monetary reform: 1 (1) “on demand” convertibility, (2) holding limits for primary assets, (3) the yield on the SDR, (4) restriction on the freedom of reserve composition, (5) the distribution of SDR allocations, (6) substitution, and (7) mandatory asset settlement.
The model used to investigate each of these arrangements is constructed in Section I, and the optimal reserve composition policies of an individual country are derived from it in Section II. The financial effects of these reserve supply arrangements on countries in different situations, as well as the extension of the analysis to a world with additional reserve assets, are treated in Section III. The final section sums up the conclusions of the analysis.
Mr. Williamson, Advisor in the Research Department, is a graduate of the London School of Economics and Political Science and of Princeton University. He has been a lecturer at the University of York, England, and a consultant to Her Majesty’s Treasury and was on leave from his post as a professor at the University of Warwick, England, when this paper was written. He has contributed a number of articles to economic journals.
In addition to colleagues in the Fund, the author is indebted to participants in seminars at Columbia University and the Johns Hopkins University (particularly to Miss N. Goyal and Mr. S. Leite) for helpful comments on a previous draft of this paper. Views expressed are those of the author.
Discussions of the Committee of Twenty (formally the Committee on Reform of the International Monetary System and Related Issues), a committee of the International Monetary Fund’s Board of Governors, in 1973–74.
Since the changes considered in the paper include variations in the yield on the SDR, this implies that the demand for reserves is assumed to be insensitive to the rate of interest. The empirical evidence seems to support this assumption. See John Williamson, “Surveys in Applied Economics: International Liquidity,” Economic Journal, Vol. 83 (September 1973), p. 696.
For a survey of this literature, see ibid., pp. 688–97.
Seigniorage benefits can be measured either from a flow standpoint as the present value of reserve credit received during the current period, or—as in the present paper—from a stock standpoint as the income on cumulative past receipts of reserve credit. See Harry G. Johnson, “Appendix: A Note on Seigniorage and the Social Saving from Substituting Credit for Commodity Money,” in Monetary Problems of the International Economy, ed. by Robert A. Mundell and Alexander K. Swoboda (University of Chicago Press, 1969), p. 324.
The analysis of the reserve currency system essentially follows that in John Williamson, “Liquidity and the Multiple Key-Currency Proposal,” American Economic Review, Vol. 53 (June 1963), pp. 427–33.
The first suggestion along these lines was made by Maxwell Stamp, “The Reform of the International Monetary System,” Moorgate and Wall Street, Summer 1965, p. 12. It was first included in official proposals as the “third approach” to asset settlement in Reform of the International Monetary System: A Report by the Executive Directors to the Board of Governors, International Monetary Fund (Washington, 1972), Chap. 3, par. 4.