International Reserves and Interest Rates

Orientador(a): Márcio Garcia

Over the past two decades, the level of international reserves in emerging economies increased significantly. In Brazil, the 2019 level of around 360 billion dollars was considered high by some metrics, based on the precautionary motive. On the other hand, in addition to the opportunity cost, Latin America is also characterized by historically high costs of holding reserves, due to the payment of positive and high interest rates. Behind any model in the literature that studies the optimal level of reserves, there is a trade-off between the insurance benefits and the costs associated with the accumulation of reserves, so that a significant change in this rate is expected to be relevant in the optimization made by the Central Bank. In that sense, recently, the policy-related interest rate in Brazil (Selic) decreased considerably, from 14.25% until October 2016 to 2.25% until June 2020, an all-time low. Addressing this issue, this thesis studies the effect of this change in the direction of Brazil’s monetary policy in the management of foreign exchange reserves. Our counterfactual results show that the net FX reserves level —a benchmark adopted by the Central Bank since August 2019 —, would have fallen in this period, but the decline in the interest rates made it possible for the Central Bank to keep a roughly stable level until 2019.